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Tight Money Policies and Inflation Revisited

Listed author(s):
  • Bhattacharya, Joydeep
  • Kudoh, N

This paper reconsiders the link between tight money policies and inflation in the spirit of Sargent and Wallace's (1981) influential paper "Some Unpleasant Monetarist Arithmetic''. A standard neoclassical model with production, capital, bonds, and return-dominated currency is used to study the long-run effects on inflation of a tightening of monetary policy engineered via a open market sale of bonds. The potential for tight money policies to be inflationary (unpleasant arithmetic) is shown to exist even when the real interest rate is below the growth rate of the economy. Equilibria exhibiting unpleasant arithmetic can be stable. In contrast, when monetary policy is conducted via an inflation target rule, the only stable equilibrium is the one that exhibits pleasant arithmetic. The two monetary policy rules therefore produce sharply different predictions about the likely observability of unpleasant arithmetic in real-world economies.

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Paper provided by Iowa State University, Department of Economics in its series Staff General Research Papers Archive with number 5085.

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Date of creation: 01 May 2002
Publication status: Published in Canadian Journal of Economics, May 2002, vol. 35 no. 2, pp. 185-217
Handle: RePEc:isu:genres:5085
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