Abstract
In a 1989 paper, B. Taub showed, contrary to T. Bewley's conjecture, that when income is subject to an aggregate shock, inflation may be the optimal policy. This paper shows that the inflation result is due to an algebraic mistake in the calculation of the first-order condition. When income is subject to an aggregate shock, deflation is always the optimal policy if the driving process has an AR(1) representation. Moreover, for a stationary AR(1) process, the rate of deflation exceeds the rate of time preference, as Bewley conjectured. Copyright 1992 by Economics Department of the University of Pennsylvania and the Osaka University Institute of Social and Economic Research Association.
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