The Comeback of Inflation as an Optimal Public Finance Tool
by Giovanni Di Bartolomeoa, Patrizio Tirellib and Nicola Acocellac
We challenge the widely held belief that New Keynesian
models cannot predict optimal positive inflation rates. In fact,
interest rates are justified by the Phelps argument that monetary
financing can alleviate the burden of distortionary taxation.
We obtain this result because, in contrast with previous
contributions, our model accounts for public transfers
as a component of fiscal outlays. We also contradict the view
that the Ramsey policy should minimize inflation volatility
and induce near-random-walk dynamics of public debt in the
long run. In our model it should instead stabilize debt-to-GDP
ratios in order to mitigate steady-state distortions. Our results
thus provide theoretical support to policy-oriented analyses
which call for a reversal of debt accumulated in the aftermath
of the 2008 financial crisis.
JEL Codes: E52, E58, J51, E24.
Full article (PDF, 28 pages, 510 kb)
a Department of Economics and Law, Sapienza University of Rome
b DEMS, University of Milan Bicocca
c MEMOTEF, Sapienza University of Rome