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Price Stability vs. Low Inflation in Germany: An Analysis of Costs and Benefits

  • Karl-Heinz Todter
  • Gerhard Ziebarth
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    We empirically investigate the costs and benefits of going from low inflation to price stability in the case of Germany. Recent empirical evidence on the sacrifice ratio suggests that the break-even point at which the permanent benefits of reducing the trend rate of inflation by 2 percentage points exceeds the temporary costs in terms of output losses is below 0.3% of GDP. We analyze the welfare implications of the interactions even of moderate rates of inflation with the distorting effects of the German tax system. Four areas of economic activity are considered: intertemporal allocation of consumption, demand for owner-occupied housing, money demand, and government debt service. We estimate the direct welfare effects of reducing the rate of inflation as well as the indirect tax revenue effects. We find that reducing the inflation rate by 2 percentage points permanently increases welfare by 1.4% of GDP. Finally, the optimal rate of disinflation is considered.

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    File URL: http://www.nber.org/papers/w6170.pdf
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    Paper provided by National Bureau of Economic Research, Inc in its series NBER Working Papers with number 6170.

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    Date of creation: Sep 1997
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    Publication status: published as The Costs and Benefits of Price Stability. Feldstein, Martin, ed., Chicago: The University of Chicago Press, 1999, pp. 47-94.
    Handle: RePEc:nbr:nberwo:6170
    Note: ME
    Contact details of provider: Postal: National Bureau of Economic Research, 1050 Massachusetts Avenue Cambridge, MA 02138, U.S.A.
    Phone: 617-868-3900
    Web page: http://www.nber.org
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    1. Mishkin, Frederic S., 1992. "Is the Fisher effect for real? : A reexamination of the relationship between inflation and interest rates," Journal of Monetary Economics, Elsevier, vol. 30(2), pages 195-215, November.
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    8. Mervyn A. King & Don Fullerton, 1983. "The Taxation of Income from Capital: A Comparative Study of the U.S., U.K., Sweden, and West Germany--The Theoretical Framework--," NBER Working Papers 1058, National Bureau of Economic Research, Inc.
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    12. 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.
    13. Jeffrey J. Hallman & Richard D. Porter & David H. Small, 1989. "M2 per unit of potential GNP as an anchor for the price level," Staff Studies 157, Board of Governors of the Federal Reserve System (U.S.).
    14. Beaudry, Paul & van Wincoop, Eric, 1996. "The Intertemporal Elasticity of Substitution: An Exploration Using a US Panel of State Data," Economica, London School of Economics and Political Science, vol. 63(251), pages 495-512, August.
    15. Tobin, James, 1977. "How Dead Is Keynes?," Economic Inquiry, Western Economic Association International, vol. 15(4), pages 459-68, October.
    16. Bernheim, B Douglas, 1991. "Optimal Fiscal and Monetary Policy: Some Recent Results," Journal of Money, Credit and Banking, Blackwell Publishing, vol. 23(3), pages 540-42, August.
    17. Dean Croushore, 1992. "What are the costs of disinflation?," Business Review, Federal Reserve Bank of Philadelphia, issue May, pages 3-16.
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