Inflation, Monetary Velocity, and Welfare
(237 K)
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NBER Working Paper No. 987
Issued in September 1982
NBER Program(s): EFG
This paper develops a simple general equilibrium model of a monetary economy with a capital market, in which monetary demand arises from a "cash-in-advance" constraint rather than from any direct role in the utility function. Uncertainty gives rise to a meaningful portfolio choice between money and bonds. We show that monetary velocity is increasing in the rate of inflation, and that the optimal monetary policy is that which maximizes real balances. We also show that the real rate of interest is not invariant to monetary policy: inflation lowers the real rate.
Published: Krugman, Paul, Torsten Persson and Lars E.O. Svensson. "Inflation, Interest Rates, and Welfare," Quarterly Journal of Economics, Vol. 100, 1985, pp. 6 77-695.
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