Document Type

Report

Publication Date

10-2001

Number

346

Abstract

This paper reconsiders the link between tight money policies and inflation in the spirit of Sargent and Wallace's (1981) influential paper "Some Unpleasaiit Monetarist Arithmetic". A standard neoclassical model with production, capital, bonds, and returii dominated currency is used to study the long-run effects on inflation ofa tightening ofmonetary policy engineered via a open market sale of bonds. The potential for tight money policies to.be inflationary (unpleasant arithmetic) exists even when the real interest rate is below the growth rate of the economy, and such equilibria can bestable. Incontrast, when moneta^policy isconducted viaa fixed inflation-rate rule, the only stable equilibrium is theone that exhibits pleasant arithmetic. The two monetary policy rules'therefore produce sharply different predictions about the likely observability of unpleasant arithmetic in real world economies.