Uncertainty-Induced Dynamic Inefficiency and the Optimal Inflation Rate

33 Pages Posted: 26 May 2016

Date Written: May 25, 2016

Abstract

I construct an overlapping-generations model of money with Epstein and Zin (1989) preferences and study how aggregate output uncertainty affects the optimal rate of inflation. When money only serves as savings instruments, I find that the optimality of Friedman Rule breaks up only if agents prefer late resolution of uncertainty. However, if an additional role of money as a medium of exchange is introduced, then the Friedman Rule becomes generally suboptimal regardless of agents' preferences for the timing of uncertainty resolution. The aggregate output uncertainty, nevertheless, crucially determines the level of optimal inflation rate in this case.

Keywords: money, overlapping generations, recursive preferences, optimal inflation

JEL Classification: E31, E52, E58

Suggested Citation

Jung, Kuk Mo, Uncertainty-Induced Dynamic Inefficiency and the Optimal Inflation Rate (May 25, 2016). Available at SSRN: https://ssrn.com/abstract=2784099 or http://dx.doi.org/10.2139/ssrn.2784099

Kuk Mo Jung (Contact Author)

Henan University ( email )

85 Minglun St. Shunhe
Kaifeng, Henan 475001
China

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