Government Revenue from Inflation

Abstract

What rate of inflation will yield the greatest steady state command over real resources to a government having a monopoly on the issue of fiat money? The usual answer--the rate at which the inflation elasticity of demand for real balances is unity--is correct if real income is constant but wrong if real income is rising. The answer then depends also on the growth rate and on the income elasticity of demand for real balances. The revenue-maximizing rate of inflation is generally lower for growing than for constant real income and may even be negative, that is, deflation. Many actual rates of inflation seem higher than the revenue-maximizing rate.