513 - Liquidity effects and welfare costs of inflation in a monetary equilibrium model for Europe

Wetenschappelijke publicatie
Date 6 August 1997

In this report a stochastic general equilibrium model is developed, which is intended for monetary policy analysis on a EU-level. The focus is on two central elements. First, liquidity effects of monetary policy are studied in the model. It appears that not only frictions on the credit markets, but also adjustment costs of capital and the way the labour markets reacts to a monetary shock, seem to be required in order to generate liquidity effects. Second, fiscal policy is integrated into the model. In this way the interaction between monetary and fiscal policy can be studied and the model can be used to estimate the welfare costs of inflation. In particular, the model predicts that a reduction of the inflation level from 4% to 2% leads to a (permanent) annual welfare gain of 0.6% of European GDP.