Seigniorage, Inflation, and Reputation
NBER Working Paper No. 1505 (Also Reprint No. r0828)
This paper derives a reputational equilibrum for inflation in a model in which the government obtains valuable seigniorage by issuing fiat money in echange for real resources. One insightful result is that , with contemporaneous perceptionof actual government behavior and immediate adjustment of real cash balences to new information , the Friedman elasticity solution for maximal seigniorage is the reputatoinal equilibrium. More generally , the analysis shows that the objective of maximal seigniorage produces an equilibrium inflation rate equal either to a generalization of the Friedman elasticity solution or to the rate at which the government discounts future seigniorage adjusted for the growth rate, whichever is larger. Thus, the model formalizes the conjecture that epizodes of inflation rates in excess of the Friedman solution are attributable to high discounts rates for future seigniorage. Adding aversion to high expected inflation to the model, this analysis also rationalizes the observation that inflation rates are usually less than Friedman's elasticity solution.
Published: Grossman, Herschel I. and John B. Van Huyck. "Seigniorage, Inflation, and Reputation," Journal of Monetary Economics, Vol. 18, No. 1, July 1986, pp. 21-31.