SEIGNIORAGE, OPERATING RULES, AND THE HIGH INFLATION TRAP

There may be both a high and a low inflation equilibrium when the government finances the deficit through seigniorage. Under rational expectations the high inflation equilibrium is stable, and the low inflation equilibrium unstable; under adaptive expectations or lagged adjustment of money balances with rational expectations, the low inflation equilibrium may be stable. Adding bond financing, dual equilibria remain if the government fixes the real interest rate, but a unique equilibrium is attained when the government sets a nominal anchor for the economy. The existence of dual equilibria is thus a result of the government's operating rules. © 1990 by the President and Fellows of Harvard College and the Massachusetts Institute of Technology.