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How costly is sustained low inflation for the U.S. economy?

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Listed author(s):
  • James B. Bullard
  • Steven Russell

Abstract

We study the welfare cost of inflation in a general equilibrium life cycle model with growth, costly financial intermediation, and taxes on nominal quantities. We find a stationary equilibrium of the model matches a wide variety of facts about the postwar U.S. economy. We then calculate that the inflation policy of the monetary authority has welfare consequences for agents that are an order of magnitude larger than existing estimates in the literature. These effects are large even at very low inflation rates. The bulk of the welfare cost of inflation can be attributed to the fact that inflation increases the effective tax rate on capital income.

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Paper provided by Federal Reserve Bank of St. Louis in its series Working Papers with number 1997-012.

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Date of creation: 1998
Handle: RePEc:fip:fedlwp:1997-012
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Keywords: Economic conditions - United States ; Inflation (Finance);

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  1. Andrew B. Abel & N. Gregory Mankiw & Lawrence H. Summers & Richard J. Zeckhauser, 1989. "Assessing Dynamic Efficiency: Theory and Evidence," Review of Economic Studies, Oxford University Press, vol. 56(1), pages 1-19.
  2. Christina D. Romer & David H. Romer, 1997. "Reducing Inflation: Motivation and Strategy," NBER Books, National Bureau of Economic Research, Inc, number rome97-1, June.
  3. Altig, David & Carlstrom, Charles T, 1991. "Inflation, Personal Taxes, and Real Output: A Dynamic Analysis," Journal of Money, Credit and Banking, Blackwell Publishing, vol. 23(3), pages 547-571, August.
  4. John Y. Campbell & John H. Cochrane, 1994. "By force of habit: a consumption-based explanation of aggregate stock market behavior," Working Papers 94-17, Federal Reserve Bank of Philadelphia.
  5. Attanasio, Orazio P & Weber, Guglielmo, 1995. "Is Consumption Growth Consistent with Intertemporal Optimization? Evidence from the Consumer Expenditure Survey," Journal of Political Economy, University of Chicago Press, vol. 103(6), pages 1121-1157, December.
  6. Kydland, Finn E, 1991. "Inflation, Personal Taxes, and Real Output: A Dynamic Analysis," Journal of Money, Credit and Banking, Blackwell Publishing, vol. 23(3), pages 575-579, August.
  7. Martin S. Feldstein, 1997. "The Costs and Benefits of Going from Low Inflation to Price Stability," NBER Chapters,in: Reducing Inflation: Motivation and Strategy, pages 123-166 National Bureau of Economic Research, Inc.
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