Tight Money Policies and Inflation Revisited

Abstract

In this paper we reconsider the link between tight money policies and inflation in the spirit of Sargent and Wallace's (1981) influential paper, Some unpleasant monetarist arithmetic. A standard neoclassical model with capital, bonds, and return-dominated currency is used. 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. Additionally, the likely observability of unpleasant arithmetic in real world economies is shown to depend crucially on the type of monetary policy rule that is used.