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Liquidity effects and the welfare costs of inflation in an endogenous growth model

  • C. K. Folkertsma
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    The paper has two subjects. The first subject is the development of a monetary general equilibrium model with endogenous growth. By combining the two-sector endogenous growth model and the limited participation approach, the model is able to explain the empirically observed liquidity effect of an expansionary monetary policy. The second subject is the effect of inflation on growth and economic welfare. It is shown that the traditional approach to measure the welfare costs of inflation may be misleading: It ignores the costs or benefits of the transition to the new steady state. This omission may bias estimates of the total welfare gains to be achieved by reducing inflation and of the optimal degree of disinflation. It is also argued that, once the transition is taken into account, the welfare gains of lowering inflation depend on the monetary policy rule and the fiscal response to disinflation. The two themes of the paper are related, because if the welfare costs of inflation cannot ignore the transitional dynamics, then simulating disinflation processes requires models with sensible short run properties.

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    File URL: http://www.dnb.nl/binaries/wo0607_tcm46-145924.pdf
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    Paper provided by Netherlands Central Bank, Research Department in its series WO Research Memoranda (discontinued) with number 607.

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    Date of creation: 2000
    Date of revision:
    Handle: RePEc:dnb:wormem:607
    Contact details of provider: Postal: Postbus 98, 1000 AB Amsterdam
    Web page: http://www.dnb.nl/en/

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    1. David E. Altig & Charles T. Carlstrom & Kevin J. Lansing, 1994. "Computable general equilibrium models and monetary policy advice," Proceedings, Federal Reserve Bank of Cleveland, pages 1472-1505.
    2. Kwanghee Nam & Thomas F. Cooley, 1998. "Asymmetric information, financial intermediation, and business cycles," Economic Theory, Springer, vol. 12(3), pages 599-620.
    3. Charles T. Carlstrom & Timothy S. Fuerst, 1995. "Interest rate rules vs. money growth rules: a welfare comparison in a cash-in-advance economy," Working Paper 9504, Federal Reserve Bank of Cleveland.
    4. Cooley, T.F. & Hansen, G.D., 1991. "The Welfare Costs of Moderate Inflations," Papers 90-04, Rochester, Business - General.
    5. Lawrence J. Christiano & Martin Eichenbaum, 1992. "Liquidity effects and the monetary transmission mechanism," Staff Report 150, Federal Reserve Bank of Minneapolis.
    6. Dotsey, Michael & Ireland, Peter, 1996. "The welfare cost of inflation in general equilibrium," Journal of Monetary Economics, Elsevier, vol. 37(1), pages 29-47, February.
    7. King, Robert G. & Plosser, Charles I. & Rebelo, Sergio T., 1988. "Production, growth and business cycles : I. The basic neoclassical model," Journal of Monetary Economics, Elsevier, vol. 21(2-3), pages 195-232.
    8. Lawrence J. Christiano & Martin Eichenbaum & Charles L. Evans, 1996. "Sticky price and limited participation models of money: a comparison," Working Paper Series, Macroeconomic Issues WP-96-28, Federal Reserve Bank of Chicago.
    9. Wu, Yangru & Zhang, Junxi, 1998. "Endogenous growth and the welfare costs of inflation: a reconsideration," Journal of Economic Dynamics and Control, Elsevier, vol. 22(3), pages 465-482, March.
    10. Einarsson, Tor & Marquis, Milton H, 1999. "Transitional and Steady-State Costs of Disinflation When Growth Is Endogenous," Economica, London School of Economics and Political Science, vol. 66(264), pages 489-508, November.
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