TY  - JOUR
AU  - Schmitt-Grohé,Stephanie
AU  - Uribe,Martín
TI  - Foreign Demand for Domestic Currency and the Optimal Rate of Inflation
JF  - National Bureau of Economic Research Working Paper Series
VL  - No. 15494
PY  - 2009
Y2  - November 2009
UR  - http://www.nber.org/papers/w15494
L1  - http://www.nber.org/papers/w15494.pdf
N1  - Author contact info:
Stephanie Schmitt-Grohe
Department of Economics
Columbia University
New York, NY 10027
Tel: 212/854-8059
Fax: 212/854-4010
E-Mail: stephanie.schmittgrohe@columbia.edu

Martin Uribe
Department of Economics
Columbia University
International Affairs Building
New York, NY 10027
Tel: 212 851 4008
Fax: 212 854 8059
E-Mail: martin.uribe@columbia.edu
AB  - More than half of U.S. currency circulates abroad. As a result, much of the seignorage income of the United States is generated outside of its borders. In this paper we characterize the Ramsey-optimal rate of inflation in an economy with a foreign demand for its currency. In the absence of such demand, the model implies that the Friedman rule—deflation at the real rate of interest—maximizes the utility of the representative domestic consumer. We show analytically that once a foreign demand for domestic currency is taken into account, the Friedman rule ceases to be Ramsey optimal. Calibrated versions of the model that match the range of empirical estimates of the size of foreign demand for U.S. currency deliver Ramsey optimal rates of inflation between 2 and 10 percent per annum. The domestically benevolent government finds it optimal to impose an inflation tax as a way to extract resources from the rest of the world in the form of seignorage revenue.
ER  -