Optimal Inflation Policy

35 Pages Posted: 19 Jul 2004

See all articles by Lawrence H. Summers

Lawrence H. Summers

Harvard University; National Bureau of Economic Research (NBER); Harvard University - Harvard Kennedy School (HKS)

Date Written: May 1979

Abstract

This paper considers the problem of optimal long run monetary policy. It shows that optimal inflation policy involves trading off two quite different considerations. First, increases in the rate of inflation tax the holding of many balances, leading to a deadweight loss as excessive resources are devoted to economizing on cash balances. Second, increases in the rate of inflation raise capital intensity. As long as the economy has a capital stock short of the golden rule level, increases in capita intensity raise the level of consumption. Ignoring the second consideration leads to the common recommendation that the money growth rate be set so that the nominal interest rate is zero. Taking it into account can lead to significant modifications in the "full liquidity rule." Inter-actions of inflation policy with financial intermediation and taxation are also considered. The results taken together suggest that inflation can have important welfare effects, and that optimal inflation policy is an empirical question, which depends on the structure of the economy.

Suggested Citation

Summers, Lawrence H., Optimal Inflation Policy (May 1979). NBER Working Paper No. w0354. Available at SSRN: https://ssrn.com/abstract=260529

Lawrence H. Summers (Contact Author)

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National Bureau of Economic Research (NBER)

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Harvard University - Harvard Kennedy School (HKS) ( email )

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