The Optimal Rate of Secular Inflation

Abstract

A generalized Keynes-Hicks macromodel is used to show that, given a demand function for money which has constant price and income elasticities, the elasticity of the magnitude of demand-induced recessions with respect to the rate of secular inflation is -1. An international cross-section of developed countries indicates that the best-fitting demand function for money has constant elasticities and the best-fitting relationship between the rate of secular inflation and the magnitude of recessions indeed has a constant elasticity of about -1. The estimated gains from secular inflation, combined with a measure of the familiar Bailey losses, yield empirical estimates of optimal rates of secular inflation.