On the Welfare Cost of Inflation and the Recent Behavior of Money Demand
Post-1980 U.S. data trace out a stable long-run money demand relationship of Cagan's semi-log form between the M1-income ratio and the nominal interest rate, with an interest semi-elasticity below 2. Integrating under this money demand curve yields estimates of the welfare costs of modest departures from Friedman's zero nominal interest rate rule for the optimum quantity of money that are quite small. The results suggest that the Federal Reserve's current policy, which generates low but still positive rates of inflation, provides an adequate approximation in welfare terms to the alternative of moving all the way to the Friedman rule.
I would like to thank Mark Gertler, Ed Nelson, and an anonymous referee for extremely helpful comments and suggestions on previous drafts of this paper. The views expressed herein are those of the author(s) and do not necessarily reflect the views of the National Bureau of Economic Research.
Peter N. Ireland, 2009. "On the Welfare Cost of Inflation and the Recent Behavior of Money Demand," American Economic Review, American Economic Association, vol. 99(3), pages 1040-52, June. citation courtesy of