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A Theory of Inflation: The Law of Motion for Inflation under the MDC-based Procedure

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  • Harashima, Taiji

Abstract

In this paper, I construct an inflation model in an economy where the government and households behave under a procedure based on the maximum degree of comfortability (MDC) to reach steady state. MDC indicates the state at which the combination of revenues and assets is felt most comfortable. I show that, if MDCs of the government and households are not consistent, inflation accelerates (or decelerates) because the government behaves to match the rate of increase of its real obligations with its MDC, but households and firms behave to match the real interest rate with household’s MDC. This inconsistency or contradiction must be resolved by acceleration (or deceleration) of inflation. To control inflation, therefore, a truly independent central bank is needed because MDC is a type of preference. The central bank can control the government’s MDC by forcing the government to increase its real obligations and thereby control inflation.

Suggested Citation

  • Harashima, Taiji, 2019. "A Theory of Inflation: The Law of Motion for Inflation under the MDC-based Procedure," MPRA Paper 113161, University Library of Munich, Germany.
    • Handle: RePEc:pra:mprapa:113161
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    JEL classification:

    • E31 - Macroeconomics and Monetary Economics - - Prices, Business Fluctuations, and Cycles - - - Price Level; Inflation; Deflation
    • E50 - Macroeconomics and Monetary Economics - - Monetary Policy, Central Banking, and the Supply of Money and Credit - - - General

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