On the Welfare Cost of Inflation and the Recent Behavior of Money Demand

27 Pages Posted: 22 Jun 2008 Last revised: 9 Jan 2022

See all articles by Peter N. Ireland

Peter N. Ireland

Boston College - Department of Economics

Date Written: June 2008

Abstract

Post-1980 U.S. data trace out a stable long-run money demand relationship of Cagan's semi-log form between the M1-income ratio and the nominal interest rate, with an interest semi-elasticity below 2. Integrating under this money demand curve yields estimates of the welfare costs of modest departures from Friedman's zero nominal interest rate rule for the optimum quantity of money that are quite small. The results suggest that the Federal Reserve's current policy, which generates low but still positive rates of inflation, provides an adequate approximation in welfare terms to the alternative of moving all the way to the Friedman rule.

Suggested Citation

Ireland, Peter N., On the Welfare Cost of Inflation and the Recent Behavior of Money Demand (June 2008). NBER Working Paper No. w14098, Available at SSRN: https://ssrn.com/abstract=1149344

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