The Optimal Inflation Target in an Economy with Limited Enforcement

Federal Reserve Bank of St. Louis Working Paper 2007-037C

36 Pages Posted: 13 Jan 2010

See all articles by Gaetano Antinolfi

Gaetano Antinolfi

Washington University in St. Louis - Department of Economics

Costas Azariadis

Federal Reserve Banks - Federal Reserve Bank of St. Louis

James Bullard

Federal Reserve Banks - Federal Reserve Bank of St. Louis

Multiple version iconThere are 3 versions of this paper

Date Written: January 12, 2010

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 and public information. Households are segmented 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 interest 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 inflation rate is positive, because inflation reduces the value of the outside option for credit agents and raises their debt limits.

Keywords: Deflation, debt constraints, limited participation, monetary policy, Friedman rule

JEL Classification: E31, E42, E58

Suggested Citation

Antinolfi, Gaetano and Azariadis, Costas and Bullard, James, The Optimal Inflation Target in an Economy with Limited Enforcement (January 12, 2010). Federal Reserve Bank of St. Louis Working Paper 2007-037C. Available at SSRN: https://ssrn.com/abstract=1535369 or http://dx.doi.org/10.2139/ssrn.1535369

Gaetano Antinolfi (Contact Author)

Washington University in St. Louis - Department of Economics ( email )

One Brookings Drive
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314-935-4156 (Fax)

Costas Azariadis

Federal Reserve Banks - Federal Reserve Bank of St. Louis ( email )

411 Locust St
Saint Louis, MO 63011
United States

James Bullard

Federal Reserve Banks - Federal Reserve Bank of St. Louis ( email )

P.O. Box 442
411 Locust Street
St. Louis, MO 63166
United States
314-444-8576 (Phone)

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