Seigniorage,inflation, and reputation

This paper derives a reputational equilibrium for inflation in a model in which the sovereign obtains valuable seigniorage by issuing fiat money in exchange for real resources. With contemporaneous perception of actual sovereign behavior and immediate adjustment of real cash balances to new information, the Friedman elasticity solution for maximal seigniorage is a reputational equilibrium. More generally, the objective of maximal seigniorage produces an equilibrium inflation rate equal either to a generalization of the Friedman elasticity solution or to the rate at which the sovereign discounts future seigniorage adjusted for the growth rate, whichever is larger. The model formalizes the conjecture that inflation rates in excess of the Friedman solution are attributable to high discount rates for future seigniorage.