According to standard monetary theory, optimal monetary policy involves slight deflation. Central banks, however, advocate zero inflation. Is there a significant welfare difference between zero inflation and optimal deflation? The answer hinges on the behavior of money demand at low nominal interest rates. Estimates of a general money demand function imply that there is not a significant difference: zero inflation yields roughly 90 percent of the total benefits to be gained by moving from 5 percent inflation to optimal deflation.
Amanda L. Kramer
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