Inflation Tax and Money Essentiality

This chapter addresses the issue of money essentiality using Brock’s (1975) model. We present an argument which casts doubt on the conclusion reached by Obstfeld and Rogoff (1983), henceforth called O–R, based on the same theoretical framework. According to O–R, speculative hyperinflation—under a pure fiat money regime—can be ruled out only when severe restrictions are placed on individual preferences, e.g., agents must have infinitely negative utility when their real balances are zero. We argue that this restriction can be tested with data from hyperinflation experiments by looking at the behavior of the inflation tax, as real balances approach zero.