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Growth and the Effects of Inflation

  • Larry E. Jones
  • Rodolfo E. Manuelli

In this paper, we analyze the effects of changes in monetary growth rates in the context of models of endogenous growth when the demand for money comes from a cash-in-advance constraint. We explore two alternative avenues through which the rate of inflation could affect the overall long-run rate of growth of the economy. The first of these is through nominal rigidities in the tax code. The particular rigidity that we examine is for depreciation allowances that are fixed in nominal terms. The second avenue that we examine is a distortion of the labor-leisure choice when a Lucas-style model of effective labor is used. In both cases, the welfare costs and growth effects of various monetary growth rules relative to a constant money supply are studied. It is found that both the welfare costs of inflation and its growth effects are quite small at low to moderate levels of inflation. However, at rates of inflation that are high by U.S. standards but not uncommon in developing countries, the magnitude of both the growth effects and the welfare costs of inflation depend on the specification of the model. If cash and credit goods are substitutes there are no growth effects and moderate welfare effects. If the two goods are complements there are sizable growth effects and large welfare effects.

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Paper provided by National Bureau of Economic Research, Inc in its series NBER Working Papers with number 4523.

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Date of creation: Nov 1993
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Publication status: published as Journal of Economic Dynamics and Control, vol. 19, no. 8, November 1995pp. 1405-1428.
Handle: RePEc:nbr:nberwo:4523
Note: EFG
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  1. Frank Hahn, 1985. "Money and Inflation," MIT Press Books, The MIT Press, edition 1, volume 1, number 0262580624, June.
  2. Cooley, T.F. & Hansen, G.D., 1991. "Tax Distortions in a Neoclassical Monetary Economy," RCER Working Papers 265, University of Rochester - Center for Economic Research (RCER).
  3. De Gregorio, Jose, 1992. "Economic growth in Latin America," Journal of Development Economics, Elsevier, vol. 39(1), pages 59-84, July.
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  5. Sergio Rebelo, 1999. "Long Run Policy Analysis and Long Run Growth," Levine's Working Paper Archive 2114, David K. Levine.
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  7. Matsuyama, Kiminori, 1991. "Endogenous Price Fluctuations in an Optimizing Model of a Monetary Economy," Econometrica, Econometric Society, vol. 59(6), pages 1617-31, November.
  8. Larry E. Jones & Rodolfo Manuelli, 1990. "A Convex Model of Equilibrium Growth," NBER Working Papers 3241, National Bureau of Economic Research, Inc.
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  12. Cooley, T.F. & Hansen, G.D., 1988. "The Inflation Tax In A Real Business Cycle Model," RCER Working Papers 155, University of Rochester - Center for Economic Research (RCER).
  13. Lucas, Robert Jr., 1982. "Interest rates and currency prices in a two-country world," Journal of Monetary Economics, Elsevier, vol. 10(3), pages 335-359.
  14. King, Robert G & Rebelo, Sergio, 1990. "Public Policy and Economic Growth: Developing Neoclassical Implications," Journal of Political Economy, University of Chicago Press, vol. 98(5), pages S126-50, October.
  15. Barro, R.J., 1988. "Government Spending In A Simple Model Of Endogenous Growth," RCER Working Papers 130, University of Rochester - Center for Economic Research (RCER).
  16. Stanley Fischer, 1991. "Growth, Macroeconomics, and Development," NBER Working Papers 3702, National Bureau of Economic Research, Inc.
  17. Hartman, Richard, 1987. "Monetary Uncertainty and Investment in an Optimizing, Rational Expectations Model with Income Taxes and Government Debt," Econometrica, Econometric Society, vol. 55(1), pages 169-76, January.
  18. William Easterly, 1989. "Policy Distortions, Size of Government, and Growth," NBER Working Papers 3214, National Bureau of Economic Research, Inc.
  19. Orphanides, Athanasios & Solow, Robert M., 1990. "Money, inflation and growth," Handbook of Monetary Economics, in: B. M. Friedman & F. H. Hahn (ed.), Handbook of Monetary Economics, edition 1, volume 1, chapter 6, pages 223-261 Elsevier.
  20. Roubini, Nouriel & Sala-i-Martin, Xavier, 1995. "A growth model of inflation, tax evasion, and financial repression," Journal of Monetary Economics, Elsevier, vol. 35(2), pages 275-301, April.
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  23. Gomme, Paul, 1993. "Money and growth revisited : Measuring the costs of inflation in an endogenous growth model," Journal of Monetary Economics, Elsevier, vol. 32(1), pages 51-77, August.
  24. Imrohoroglu, Ayse, 1992. "The welfare cost of inflation under imperfect insurance," Journal of Economic Dynamics and Control, Elsevier, vol. 16(1), pages 79-91, January.
  25. Lucas, Robert E, Jr, 1990. "Supply-Side Economics: An Analytical Review," Oxford Economic Papers, Oxford University Press, vol. 42(2), pages 293-316, April.
  26. Auerbach, Alan J, 1979. "Inflation and the Choice of Asset Life," Journal of Political Economy, University of Chicago Press, vol. 87(3), pages 621-38, June.
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  28. Lucas, Robert Jr., 1988. "On the mechanics of economic development," Journal of Monetary Economics, Elsevier, vol. 22(1), pages 3-42, July.
  29. Abel, Andrew B, 1981. "Taxes, Inflation, and the Durability of Capital," Journal of Political Economy, University of Chicago Press, vol. 89(3), pages 548-60, June.
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  31. Stockman, Alan C., 1981. "Anticipated inflation and the capital stock in a cash in-advance economy," Journal of Monetary Economics, Elsevier, vol. 8(3), pages 387-393.
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