Working Paper: NBER ID: w15494
Authors: Stephanie Schmitt-Grohé; Martín Uribe
Abstract: More than half of U.S. currency circulates abroad. As a result, much of the seignorage income of the United States is generated outside of its borders. In this paper we characterize the Ramsey-optimal rate of inflation in an economy with a foreign demand for its currency. In the absence of such demand, the model implies that the Friedman rule--deflation at the real rate of interest--maximizes the utility of the representative domestic consumer. We show analytically that once a foreign demand for domestic currency is taken into account, the Friedman rule ceases to be Ramsey optimal. Calibrated versions of the model that match the range of empirical estimates of the size of foreign demand for U.S. currency deliver Ramsey optimal rates of inflation between 2 and 10 percent per annum. The domestically benevolent government finds it optimal to impose an inflation tax as a way to extract resources from the rest of the world in the form of seignorage revenue.
Keywords: No keywords provided
JEL Codes: E41; E5
Edges that are evidenced by causal inference methods are in orange, and the rest are in light blue.
| Cause | Effect |
|---|---|
| foreign demand for domestic currency (F31) | optimal inflation rate (E31) |
| optimal inflation rate (E31) | deviation from the Friedman rule (E19) |
| foreign demand for domestic currency (F31) | deviation from the Friedman rule (E19) |
| optimal inflation rate (E31) | seignorage revenue (H27) |
| foreign demand for domestic currency (F31) | domestic consumption (E20) |