Inflation Level and Inflation Volatility : A Seigniorage Argument

In this paper we contribute to the literature on environments with active fiscal and accommodating monetary policy. We show that this framework is able to explain the positive relationship between the steady state level of inflation and business cycle inflation volatility observable in the data. In addition, we contribute to the theoretical literature by demonstrating that multiple equilibria arise when the elasticity of money demand exceeds the gross real interest rate. Finally, we prove that the monotonic relationship between steady state inflation level and business cycle inflation volatility holds both in the presence of unique as well as multiple equilibria