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Foreign demand for domestic currency and the optimal rate of inflation

Author: Stephanie Schmitt-Grohe; Martin Uribe; National Bureau of Economic Research.
Publisher: Cambridge, Mass. : National Bureau of Economic Research, ©2009.
Series: Working paper series (National Bureau of Economic Research), no. 15494.
Edition/Format:   eBook : Document : EnglishView all editions and formats
Summary:
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  Read more...
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Material Type: Document, Internet resource
Document Type: Internet Resource, Computer File
All Authors / Contributors: Stephanie Schmitt-Grohe; Martin Uribe; National Bureau of Economic Research.
OCLC Number: 465330103
Description: 1 online resource (17 pages).
Series Title: Working paper series (National Bureau of Economic Research), no. 15494.
Responsibility: 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.

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