Foreign Demand for Domestic Currency and the Optimal Rate of Inflation

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18 citations0/0 files storedRePEc: Research Papers in Economics

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Monetary Policy and Economic Impact Global Financial Crisis and Policies Economic theories and models

Abstract

We characterize the Ramsey optimal rate of inflation in a model with a foreign demand for domestic currency. In the absence of such demand, the model implies that the Friedman rule—deflation at the real rate of interest—is optimal. We show analytically that in the presence of a foreign demand for domestic currency, this result breaks down. Calibrated versions of the model deliver optimal annual rates of inflation between 2% and 10%. The domestically benevolent government imposes an inflation tax to extract resources from the rest of the world in the form of seignorage revenue.

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1996The Location of U.S. Currency: How Much Is Abroad?1998Blessing or curse? Foreign and underground demand for euro notes 2004Optimal fiscal and monetary policy under imperfect competition 2010Is the International Role of the Dollar Changing?

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2016Infrequent but Long-Lived Zero-Bound Episodes and the Optimal Rate of Inflation 2015Shoe-Leather Costs in the Euro Area and the Foreign Demand for Euro Banknotes

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