On the Optimal Inflation Rate
Markus K. Brunnermeier, Yuliy Sannikov
American Economic Review · 2016 · Volume 106 · Issue 5
Abstract
In our incomplete markets economy households choose portfolios consisting of risky (uninsurable) capital and money. Money is a bubble, it has positive value even though it yields no payoff. The market outcome is constrained Pareto inefficient due to a pecuniary externality. Each individual agent takes the real interest rate as given, while in the aggregate it is driven by the economic growth rate, which in turn depends on individual portfolio decisions. Higher inflation due to higher money growth lowers the real interest rate on money and tilts the portfolio choice towards physical capital investment. Modest inflation boosts growth rate and welfare.
Keywords
Household Saving, Personal Finance, Incomplete Markets, Investment, Capital, Intangible Capital, Capacity, Price Level, Inflation, Deflation, Interest Rates: Determination, Term Structure, and Effects, Money Supply, Credit, Money Multipliers, Portfolio Choice, Investment Decisions
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