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Uncertainty-Induced Dynamic Inefficiency and the Optimal Inflation Rate

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  • Jung, Kuk Mo

Abstract

I construct an overlapping-generations model of money with Epstein and Zin (1989) preferences and study how aggregate output uncertainty affects the optimal rate of inflation. When money only serves as savings instruments, I find that the optimality of Friedman Rule breaks up only if agents prefer late resolution of uncertainty. However, if an additional role of money as a medium of exchange is introduced, then the Friedman Rule becomes generally suboptimal regardless of agents' preferences for the timing of uncertainty resolution. The aggregate output uncertainty, nevertheless, crucially determines the level of optimal inflation rate in this case.

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  • Jung, Kuk Mo, 2016. "Uncertainty-Induced Dynamic Inefficiency and the Optimal Inflation Rate," MPRA Paper 69715, University Library of Munich, Germany.
    • Handle: RePEc:pra:mprapa:69715
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    More about this item

    Keywords

    money; overlapping generations; recursive preferences; optimal inflation;
    All these keywords.

    JEL classification:

    • E31 - Macroeconomics and Monetary Economics - - Prices, Business Fluctuations, and Cycles - - - Price Level; Inflation; Deflation
    • E52 - Macroeconomics and Monetary Economics - - Monetary Policy, Central Banking, and the Supply of Money and Credit - - - Monetary Policy
    • E58 - Macroeconomics and Monetary Economics - - Monetary Policy, Central Banking, and the Supply of Money and Credit - - - Central Banks and Their Policies

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