Inflationary Finance and Growth

Abstract

The optimal rate of monetary expansion is derived for the case when the government resorts to deficit financing to finance its development expenditure. It is argued that, while higher rates of monetary expansion increase investment and contribute to future consumption, the consequent inflation imposes welfare costs by reducing the level of real balances held by the public. A theoretical framework is developed and its empirical implications considered by deriving the optimal rate of monetary expansion which maximizes the discounted flow of total consumption--material consumption minus the disutility of holding suboptimal levels of real balances--over time.

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