Foreign Demand for Domestic Currency and the Optimal Rate of Inflation

Martín Uribe () and Schmitt-Grohé, Stephanie
Authors registered in the RePEc Author Service: Stephanie Schmitt-Grohe

No 7549, CEPR Discussion Papers from C.E.P.R. Discussion Papers

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 year. 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.

Keywords: Foreign demand for currency; Friedman rule; Optimal inflation rate (search for similar items in EconPapers)
JEL-codes: E41 (search for similar items in EconPapers)
Date: 2009-11
New Economics Papers: this item is included in nep-cba, nep-dge, nep-mac and nep-mon
References: View references in EconPapers View complete reference list from CitEc
Citations: View citations in EconPapers (4)

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Related works:
Journal Article: Foreign Demand for Domestic Currency and the Optimal Rate of Inflation (2012)
Journal Article: Foreign Demand for Domestic Currency and the Optimal Rate of Inflation (2012)
Working Paper: Foreign Demand for Domestic Currency and the Optimal Rate of Inflation (2009)
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