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Inflation, Monetary Velocity, and Welfare

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  • Paul R. Krugman
  • Torsten Persson
  • Lars E.O. Svensson

Abstract

This paper develops a simple general equilibrium model of a monetary economy with a capital market, in which monetary demand arises from a "cash-in-advance" constraint rather than from any direct role in the utility function. Uncertainty gives rise to a meaningful portfolio choice between money and bonds. We show that monetary velocity is increasing in the rate of inflation, and that the optimal monetary policy is that which maximizes real balances. We also show that the real rate of interest is not invariant to monetary policy: inflation lowers the real rate.

Suggested Citation

  • Paul R. Krugman & Torsten Persson & Lars E.O. Svensson, 1982. "Inflation, Monetary Velocity, and Welfare," NBER Working Papers 0987, National Bureau of Economic Research, Inc.
  • Handle: RePEc:nbr:nberwo:0987
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    1. Brock, William A., 1975. "A simple perfect foresight monetary model," Journal of Monetary Economics, Elsevier, vol. 1(2), pages 133-150, April.
    2. Lucas, Robert E, Jr, 1980. "Equilibrium in a Pure Currency Economy," Economic Inquiry, Western Economic Association International, vol. 18(2), pages 203-220, April.
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