The paper argues that Lucas overestimates the Friedman-Bailey type of welfare cost of inflation and neglects other important welfare effects. With an alternative interpretation of the non-observability of low interest rates than the one Lucas gave and the introduction of taxes that reduce the opportunity cost of money holding, the welfare cost shrinks to one third of Lucas' estimate. The neglected welfare effects of inflation include an adverse Baumol-Tobin effect on growth and international capital movements, historical cost accounting for tax purposes, uncertainty about the price level and the relationship between inflation, relative prices and structural change.
*Published:
CESifo Discussion Paper Nr.179, 1999, in: M. Kaser and A. Leijonhufvud(eds.), Proceedings of the IEA Conference "Monetary Theory as a Basis for Monetary Policy," Trento 1997, MacMillan (forthcoming). Journal of Policy Reform, forthcoming.
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