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American Economic Review: Vol. 99 No. 3 (June 2009)

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

Article Citation

Ireland, Peter N. 2009. "On the Welfare Cost of Inflation and the Recent Behavior of Money Demand." American Economic Review, 99(3): 1040-52.

DOI: 10.1257/aer.99.3.1040

Abstract

Post-1980 US 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 semielasticity 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. (JEL E31, E41, E52)

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Authors

Ireland, Peter N. (Boston College)

JEL Classifications

E31: Price Level; Inflation; Deflation
E41: Demand for Money
E52: Monetary Policy


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