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The Optimal Inflation Target in an Economy with Limited Enforcement

Author

Listed:
  • James Bullard

    (Federal Reserve Bank of St. Louis)

  • Costas Azariadis

    (Washington University)

  • Gaetano Antinolfi

    (Washington University)

Abstract

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.

Suggested Citation

  • James Bullard & Costas Azariadis & Gaetano Antinolfi, 2008. "The Optimal Inflation Target in an Economy with Limited Enforcement," 2008 Meeting Papers 915, Society for Economic Dynamics.
  • Handle: RePEc:red:sed008:915
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    References listed on IDEAS

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    Citations

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    Cited by:

    1. Aleksandra Halka, 2016. "How the central bank’s reaction function in small open economies evolved during the crisis," Bank i Kredyt, Narodowy Bank Polski, vol. 47(4), pages 301-318.
    2. Di Bartolomeo Giovanni & Tirelli Patrizio & Acocella Nicola, 2010. "Trend inflation, endogenous mark-ups and the non-vertical Phillips curve," wp.comunite 0065, Department of Communication, University of Teramo.
    3. Sanches, Daniel & Williamson, Stephen, 2010. "Money and credit with limited commitment and theft," Journal of Economic Theory, Elsevier, vol. 145(4), pages 1525-1549, July.
    4. Jung, Kuk Mo, 2016. "Uncertainty-Induced Dynamic Inefficiency and the Optimal Inflation Rate," MPRA Paper 69715, University Library of Munich, Germany.
    5. repec:cuf:journl:y:2018:v:19:i:1:nozawa:yang is not listed on IDEAS
    6. Aleksandra Halka, 2015. "Lessons from the crisis.Did central banks do their homework?," NBP Working Papers 224, Narodowy Bank Polski, Economic Research Department.
    7. Stephen Williamson & Daniel Sanches, 2008. "Money and Credit with Limited Commitment," 2008 Meeting Papers 502, Society for Economic Dynamics.
    8. Claudio Cesaroni, 2017. "Optimal Long-Run Inflation and the Informal Economy," Bank of Lithuania Working Paper Series 46, Bank of Lithuania.
    9. Rufin-Willy Mantsie, 2012. "In Search of Inflation Rate Compatible with Growth Target in CEMAC Countries," Brussels Economic Review, ULB -- Universite Libre de Bruxelles, vol. 55(4), pages 329-350.

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