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The comeback of inflation as an optimal public finance tool

  • Di Bartolomeo Giovanni
  • Acocella Nicola
  • Tirelli Patrizio

We challenge the widely held belief that New-Keynesian models cannot predict optimal positive inflation rates. In fact these are justified by the Phelps argument that monetary financing can alleviate the burden of distortionary taxation. We obtain this result because, in contrast with previous contributions, our model accounts for public transfers as a component of fiscal outlays. We also contradict the view that the Ramsey policy should minimize inflation volatility and induce near-random walk dynamics of public debt in the long-run. In our model it should instead stabilize debt-to-GDP ratios in order to mitigate steady-state distortions. Our results thus provide theoretical support to policy-oriented analyses which call for a reversal of debt accumulated in the aftermath of the 2008 financial crisis.

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Paper provided by Department of Communication, University of Teramo in its series wp.comunite with number 0100.

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Date of creation: Apr 2013
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Handle: RePEc:ter:wpaper:0100
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