Disinflation and Interest-Bearing Money

Abstract

In high inflation countries, policymakers often end up paying interest on part of the money supply. Higher interest rates on money have been used as a disinflationary policy. This paper analyses the effectiveness of such a policy in the context of a closed-economy, staggered-prices model. Both a permanent and a temporary rise in the interest rate on money provoke an initial fall in inflation, at the expense of a recession. When the rise is temporary, however, the initial inflation slowdown is eventually followed by an upsurge of inflation over the level prevailing before the policy was implemented.

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