Working Paper: NBER ID: w0987
Authors: Paul R. Krugman; Torsten Persson; Lars E.O. Svensson
Abstract: This paper develops a simple general equilibrium model of a monetary economy with a capital market, in which monetary demand arises from a "cash-in-advance" constraint rather than from any direct role in the utility function. Uncertainty gives rise to a meaningful portfolio choice between money and bonds. We show that monetary velocity is increasing in the rate of inflation, and that the optimal monetary policy is that which maximizes real balances. We also show that the real rate of interest is not invariant to monetary policy: inflation lowers the real rate.
Keywords: inflation; monetary velocity; welfare; general equilibrium model
JEL Codes: E31; E52
Edges that are evidenced by causal inference methods are in orange, and the rest are in light blue.
| Cause | Effect |
|---|---|
| expected inflation (E31) | monetary velocity (E41) |
| monetary velocity (E41) | liquidity (E41) |
| liquidity (E41) | welfare costs (I30) |
| inflation (E31) | real balances (F31) |
| optimal monetary policy (E63) | real balances (F31) |
| inflation (E31) | real interest rate (E43) |