The Inflation Tax, Variable Time Preference, and the Business Cycle

Abstract

This paper investigates the impact of anticipated inflation on features of the business cycle in the presence of recursive but intertemporally dependent tastes. Intertemporal dependence is induced by the presence of a variable or endogenous individual rate of time preference. Quantitative experiments indicate that variability in the rate of time preference can enhance the contribution of monetary shocks to the fluctuations of real variables. Another implication of the variable-time-preference model is that, unlike the fixed time preference model, the business cycle features in high inflation and low inflation economies can be very different. The contribution of monetary shocks to fluctuations increases partly because endogenous time preference accentuates inflation-tax effects, which are already present in the standard framework because of the presence of cash-in-advance constraints. The change in the relative role of monetary shocks is also related to how variable time preference alters the effects of technology shocks, which can be quantitatively or qualitatively different in comparison to the standard model, depending on the parameters of the model.

Liquidity Effects, Variable Time Preference, and Optimal Monetary Policy

“…The results ofLahiri (2002) can be interpreted in a similar way. In that paper, money growth and real activity are negatively correlated, making the representative agent more patient and consequently more tolerant of greater sacrifices in current consumption and output.5 This suggests that monetary shocks have a larger contribution to fluctuations in variables, as in the case ofLahiri (2002).6 In a sense, the optimal policy is computed by comparing competitive equilibrium work effort with the optimal level of work effort. The presence of endogenous time preference not only changes the equilibrium work effort, but also the optimal work effort that can be achieved when all of the distortions in the economy have been removed.…”

“…See for example, Chang et al (1998), Devereux (1991), Dolmas and Wynne (1998), Ikeda (2001), Nishimura and Shimomura (2002), among others. A relatively unexplored issue that has been addressed in Lahiri (2002) is the impact of monetary shocks on economies characterized by endogenous time preference. She finds that inflation-tax effects are enhanced in the presence of endogenous time preference, leading to a larger contribution of monetary shocks to the fluctuations of real variables.…”

“…This result, in part, motivates the study of optimal monetary policy that is conducted in this paper. The model of this paper, however, differs from the monetary model in Lahiri (2002), which is an extension of the standard "cash-in-advance" model of the Cooley and Hansen (1989). Here we examine the role of monetary policy in the presence of an additional trading friction, one that is typical of the class of "liquidity models" of the monetary transmission mechanism.…”

“…The original formulation was due to Uzawa (1968), which was extended and refined in Epstein's work. For a discussion of economists' views about the increasing marginal impatience assumption see Lahiri (2002). experiments conducted in this paper is to regard them as sensitivity checks.…”

Health expenditures and inequality: a political economy perspective

“…6. This type of cardinal assumption is typically made in models with endogenous time preference. While Chakraborty and Das assume 0< σ <1, others, such as Lahiri (2002), assume it to be negative.…”