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  3. American Economic Review
  4. May 2016
  5. On the Optimal Inflation Rate

On the Optimal Inflation Rate

  • Markus K. Brunnermeier
  • Yuliy Sannikov
American Economic Review
vol. 106, no. 5, May 2016
(pp. 484-89)
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Abstract

In our incomplete markets economy households choose portfolios consisting of risky (uninsurable) capital and money. Money is a bubble, it has positive value even though it yields no payoff. The market outcome is constrained Pareto inefficient due to a pecuniary externality. Each individual agent takes the real interest rate as given, while in the aggregate it is driven by the economic growth rate, which in turn depends on individual portfolio decisions. Higher inflation due to higher money growth lowers the real interest rate on money and tilts the portfolio choice towards physical capital investment. Modest inflation boosts growth rate and welfare.

Citation

Brunnermeier, Markus K., and Yuliy Sannikov. 2016. "On the Optimal Inflation Rate." American Economic Review, 106 (5): 484-89. DOI: 10.1257/aer.p20161076

Additional Materials

JEL Classification

  • D14 Household Saving; Personal Finance
  • D52 Incomplete Markets
  • E22 Investment; Capital; Intangible Capital; Capacity
  • E31 Price Level; Inflation; Deflation
  • E43 Interest Rates: Determination, Term Structure, and Effects
  • E51 Money Supply; Credit; Money Multipliers
  • G11 Portfolio Choice; Investment Decisions