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Dynamic Seigniorage Theory: An Exploration

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  • Maurice Obstfeld and .

Abstract

This paper shows that the optimal extraction of seigniorage implies a strong tendency for inflation to fall over time toward its socially optimal level. The point is made using a multi-period model in which (i) the government can finance deficits through bond issue or money creation, (ii) private-sector expectations are rational, and (iii) the government sets the inflation rate each period in a discretionary manner. One way to view the model is as a synthesis of the "tax-smoothing" theory of government deficits, which predicts that the inflation tax follows approximately a martingale, and of models of discretionary policy making, which predict (absent reputation effects) that inflation is likely to exceed its socially optimal level. Both predictions are modified when the two approaches to explaining inflation are merged. Reputation effects play no role in the analysis.
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  • Maurice Obstfeld and ., 1997. "Dynamic Seigniorage Theory: An Exploration," Center for International and Development Economics Research (CIDER) Working Papers C97-085, University of California at Berkeley.
    • Handle: RePEc:ucb:calbcd:c97-085
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    JEL classification:

    • E31 - Macroeconomics and Monetary Economics - - Prices, Business Fluctuations, and Cycles - - - Price Level; Inflation; Deflation
    • E63 - Macroeconomics and Monetary Economics - - Macroeconomic Policy, Macroeconomic Aspects of Public Finance, and General Outlook - - - Comparative or Joint Analysis of Fiscal and Monetary Policy; Stabilization; Treasury Policy
    • C73 - Mathematical and Quantitative Methods - - Game Theory and Bargaining Theory - - - Stochastic and Dynamic Games; Evolutionary Games

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