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We offer an explanation of why optimal policy under commitment requires weaker reaction to supply shock, reflected in the failure of the Taylor principle. This lesson seems to be prevalent among central banks and yet has been analyzed incomprehensively in the economic literature.

The paradox is that inflationary finance is supposed to repress money substitutes, while in practice chronic inflation economies introduced indexed money substitutes on a large scale. My explanation is that the regime in the latter economies was probably closer to discretion than to rules. It is shown that under discretion it is optimal to introduce indexed money to protect the liquidity position, in the face of adverse expectations.

Inflation inertia may be quite tenacious because of the simultaneous interaction between policy actions and inflationary expectations under imperfect credibility. This result is particularly relevant for understanding some of the failed efforts to stabilize inflation in South America. This article deals with the issue of inertia in the framework of imperfect information about the type of the policymaker and extends the existing models to an infinite horizon. Because policymakers do not have perfect control of inflation, a frivolous stabilizer may deviate from the policies of a serious stabilizer without necessarily being unmasked immediately. When the difference in the ability of strong and weak policymakers to control inflation is large, unexpected inflation may be persistently negative for quite a while, thus causing reduced economic activity and giving the indication that credibility is low. If the policymaker persists with the stabilization, this pattern gradually disappears as his reputation rises. But before this final stage the serious policymaker has to compromise his inflation objective in view of adverse expectation about this type and pay the cost of imperfect credibility.

This paper examines the optimal behavior of a policymaker who is able to precommit (labelled ‘strong’) when the public entertains the possibility that he is either strong or weak (unable to precommit). The main result is that, in the presence of doubts about their type, it is optimal, even for strong policymakers, to partially accommodate inflationary expectations. This contrasts with Vickers (1986) who finds that when strength is conceived in terms of the relative concern for employment the strong policymaker inflates less under incomplete than under full information. The paper also provides a theory of endogenous announcements.

In a recent paper Sargent and Wallace present an example where tightening of monetary policy over a specified time interval, in conjunction with a constant deficit, leads to an increase in the rate of inflation not only beyond this interval but even from the outset. In the present paper I show how the latter result can be derived from a standard monetary-growth model of the Sidrauski-Brock type. This enables a relatively simple interpretation of the apparent paradox.

This paper examines the thesis of neutrality of government bonds in the framework of a monetary growth model with an infinitely lived representative consumer. It is shown that, unlike the case of a non-monetary economy, the additional interest on an increased national debt can be offset partly by the ‘inflation tax’ rather then by ordinary taxes. If the former option is adopted by the government, then its bonds will no longer be neutral. Various forms of non-neutrality are derived and interpreted.

Orthodox stabilization programs in Latin American countries have been notoriously unsuccessful in combating inflation, despite the imposition of stringent cuts in government deficits. In most cases inflation came down only slowly and temporarily, with concomitant declines in growth and employment. The Bolivian program, one of the only Latin American successes, is contrasted with those of Argentina, Brazil, Chile, and Mexico. The problems of dealing with chronic inflation are compared with those of hyperinflationary countries, and the influence of price and wage rigidities, expectations, and credibility is explored. The study shows that fiscal restraint is a necessary but not sufficient condition for success, and that sound management of nominal variables (the exchange rate and money supply) are also necessary. The critical role of credibility is linked with price and wage rigidities in the chronic inflation countries, whereas the unsuitability of hyperinflation is seen to increase the credibility of and thus the potential for successful stabilization programs.

We consider government intervention in the capital market by selling indexed bonds and buying non-indexed bonds of equal value. If the profits or losses of this operation are transmitted to the public which takes this into consideration then the government's intervention may have no effect on the economy. Insofar as the assumptions of the model permit real effects of the foregoing policy the impact on the economy tends to be deflationary. In analyzing this tendency a distinction is made between the case where the government intervenes in an existing market and the case where it creates a new market for indexed bonds.

This paper examines the monetary approach to the balance of payments under fixed exchange rates when domestic prices and wage rates are not fully flexible. This leads to a formulation in the spirit of a ‘disequilibrium analysis’. We analyze alternatively the cases where the prices of nontraded goods or the nominal wage rate are treated as state variables along with the stock of money. The properties of these systems are analyzed from the point of view of the momentary equilibrium and of the dynamic adjustment process.

This paper examines the effect of expansionary bank credit on inflation. It is shown that no definite relation between these phenomena can be established within the framework of an inflation tax model with long run perfect foresight.

THE PROCESS OF INFLATION is associated not only with a rising general price level, but also with uncertainty about its rate of change. It is the latter aspect of inflation that may give rise to risk premia on nominal assets as compared with a real safe asset. A possible framework for analyzing the structure of risk premia under inflationary conditions is the well-known Capital Asset Pricing Model (CAPM) developed by Sharpe and Lintner. Indeed, a number of papers have recently dealt with these risk premia by means of the CAPM framework or some close variety of it. We may mention the works of Roll [9], Sarnat [10], Fischer [4], Chen and Boness [1], and Friend, Landskroner, and Losq [5].1 The CAPM and its extentions to conditions of inflation use a microeconomic approach in a partial equilibrium analysis of the risk premia. A basic feature of the foregoing literature is the implicit treatment of inflation as exogenous. Alternatively, there is no theory to relate the real return on money (to be denoted 7r) to the other variables in the CAPM formulation. This leads to two important shortcomings. First, the covariance of 7r with the rates of return appears as completely arbitrary. Second, since X was considered as exogenous, the authors did not consider the need to include in their models the government's nominal transfer pay