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The Optimal Inflation Target in an Economy with Limited Enforcement

  • James Bullard

    (Federal Reserve Bank of St. Louis)

  • Costas Azariadis

    (Washington University)

  • Gaetano Antinolfi

    (Washington University)

We formulate the central bank's problem of selecting an optimal long-run inflation rate as the choice of a distorting tax by a planner who wishes to maximize discounted stationary utility for a heterogeneous population of infinitely-lived households in an economy with constant aggregate income. Households are divided into cash agents, who store value in currency alone, and credit agents who have access to both currency and loans. The planner's problem is equivalent to choosing inflation and nominal rates consistent with a resource constraint, and with an incentive constraint that ensures credit agents prefer the superior consumption-smoothing power of loans to that of currency. We show that the optimum implied rate of inflation is positive, and the optimum implied nominal interest rate is higher than the inflation rate, if the social welfare function weighs credit agents no more than their population fraction.

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Paper provided by Society for Economic Dynamics in its series 2008 Meeting Papers with number 915.

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Date of creation: 2008
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Handle: RePEc:red:sed008:915
Contact details of provider: Postal: Society for Economic Dynamics Christian Zimmermann Economic Research Federal Reserve Bank of St. Louis PO Box 442 St. Louis MO 63166-0442 USA
Fax: 1-314-444-8731
Web page: http://www.EconomicDynamics.org/society.htm
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  1. Abel, Andrew B., 1987. "Optimal monetary growth," Journal of Monetary Economics, Elsevier, vol. 19(3), pages 437-450, May.
  2. Aleksander Berentsen & Gabriele Camera & Christopher Waller, . "Money, Credit and Banking," IEW - Working Papers 219, Institute for Empirical Research in Economics - University of Zurich.
  3. Mirrlees, James A, 1971. "An Exploration in the Theory of Optimum Income Taxation," Review of Economic Studies, Wiley Blackwell, vol. 38(114), pages 175-208, April.
  4. Gaetano Antinolfi & Costas Azariadis & James B. Bullard, 2007. "Monetary policy as equilibrium selection," Review, Federal Reserve Bank of St. Louis, issue Jul, pages 331-342.
  5. Joydeep Bhattacharya & Joseph H. Haslag & Antoine Martin, 2004. "Heterogeneity, redistribution, and the Friedman rule," Research Working Paper RWP 04-01, Federal Reserve Bank of Kansas City.
  6. Chiu, Jonathan & Molico, Miguel, 2010. "Liquidity, redistribution, and the welfare cost of inflation," Journal of Monetary Economics, Elsevier, vol. 57(4), pages 428-438, May.
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  8. Bruce D. Smith, 2002. "Monetary Policy, Banking Crises, and the Friedman Rule," American Economic Review, American Economic Association, vol. 92(2), pages 128-134, May.
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  11. Gauti B. Eggertsson & Michael Woodford, 2003. "The Zero Bound on Interest Rates and Optimal Monetary Policy," Brookings Papers on Economic Activity, Economic Studies Program, The Brookings Institution, vol. 34(1), pages 139-235.
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  13. Foley, Duncan K & Shell, Karl & Sidrauski, Miguel, 1969. "Optimal Fiscal and Monetary Policy and Economic Growth," Journal of Political Economy, University of Chicago Press, vol. 77(4), pages 698-719, Part II, .
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  17. Timothy J. Kehoe & David K. Levine, 1992. "Debt constrained asset markets," Working Papers 445, Federal Reserve Bank of Minneapolis.
  18. Akyol, Ahmet, 2004. "Optimal monetary policy in an economy with incomplete markets and idiosyncratic risk," Journal of Monetary Economics, Elsevier, vol. 51(6), pages 1245-1269, September.
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  21. repec:hal:wpaper:halshs-00590788 is not listed on IDEAS
  22. Azariadis, Costas & Kaas, Leo, 2007. "Asset price fluctuations without aggregate shocks," Journal of Economic Theory, Elsevier, vol. 136(1), pages 126-143, September.
  23. Xavier Ragot, 2005. "A theory of low inflation in a non Ricardian economy with credit constraints," PSE Working Papers halshs-00590788, HAL.
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  26. Summers, Lawrence, 1991. "How Should Long-Term Monetary Policy Be Determined? Panel Discussion," Journal of Money, Credit and Banking, Blackwell Publishing, vol. 23(3), pages 625-31, August.
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