How Costly is Sustained Low Inflation for the U.S. Economy?

Abstract

take the form of permanent changes in the growth rate of the base money stock that produce permanent changes in the rate of inflation. We follow the bulk of the inflation-cost literature by basing our cost estimates on comparisons of alternative steady states. We follow the recent trend in applied macroeconomic theory by calibrating our model to increase the empirical credibility of its predictions. The principal goal of our calibration procedure is to produce a steady-state equilibrium that matches certain longrun-average features of U.S. postwar data. We have given the model a variety of characteristics that increase both its overall plausibility and its ability to mimic these data. The characteristics include households that live for a large but finite number of periods, exogenous technological progress, exogenous population growth, costly financial intermediation, and endogenous labor-leisure decisions. The model also includes a fairly elaborate government sector, including real expenditures (government purchases), taxes on labor and capital income, seigniorage revenue, and government debt. The importance of the role played by the government sector is a distinctive feature of our analysis. A characteristic of the observed public finance system that plays a key role in driving our results is that capital income taxes are levied on net nominal income, so that increases in the inflation rate increase effective capital income tax rates. In this respect, our analysis is similar to recent work by Feldstein (1997) and Abel (1997). However, their estimates of the cost of inflation are based largely on the tendency of higher effective capital income tax rates to increase the wedge between the before-tax and

On the welfare cost of inflation in Europe

“…Recently, for example, Bullard and Russell (2004) report welfare cost estimates that are an order of magnitude larger than our estimates, suggesting that the welfare cost of inflation question is an outstanding one in macroeconomics and monetray economics. Moreover, much of the welfare cost of inflation is borne by the poor, and thus depends on the income distribution, and cannot accurately be assessed using aggregate methods.…”

Real Interest Rate Persistence: Evidence and Implications

“…Finally, some monetary growth models allow for changes in steady-state money growth to affect the steady-state real interest rate. The seminal models of Mundell (1963) and Tobin (1965) predict that an increase in steady-state money growth lowers the steady-state real interest rate, and more recent micro-founded monetary models have similar implications (Weiss, 1980;Espinosa-Vega and Russell, 1998a,b;Bullard and Russell, 2004;Reis, 2007;Lioui and Poncet, 2008). Again, this class of models permits changes in the steadystate real interest rate without corresponding changes in consumption growth, potentially explaining a mismatch in the integration properties of the real interest rate and consumption growth.…”

The Zero Lower Bound and the Dual Mandate

“…subject to the …rm's demand schedule, (8), and the input factor demands from the …rm's cost minimization problem, (5). The value of j t+j characterizes the value of pro…ts to households j periods in the future, whereas j represents the probability that another price-setting opportunity will not take place in the next j periods.…”

“…In all cases, the policy of changing the in ‡ation target is dominated by committing to a explicit in ‡ation target or by targeting the 2 percent in ‡ation target more aggressively. Studies of the optimal in ‡ation rate in New Keynesian models (See, for example, Coibion, et al, 2010) or in models with imperfectly indexed tax systems (See, for example, Bullard and Russell, 2004) suggests that closer to zero in ‡ation is better for social welfare.…”