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The welfare costs of expected and unexpected inflation

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  • Faig, Miquel
  • Li, Zhe

Abstract

The monetary search model by Lagos and Wright (2005) is extended with imperfect information about nominal shocks as in Lucas (1972). An analytical solution exists with logarithmic preferences. In general, individuals hold precautionary balances. Calibrated to United States postwar data, the welfare cost of the monetary cycle is calculated to be small (below 0.0003% of GDP) compared to the welfare cost of the inflation tax (around 0.25% of GDP). The main reason for the minute welfare cost of the monetary cycle is its low amplitude in 1947-2007. But, monetary crashes, such as those experienced during the Great Depression, can generate important welfare costs.

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Bibliographic Info

Article provided by Elsevier in its journal Journal of Monetary Economics.

Volume (Year): 56 (2009)
Issue (Month): 7 (October)
Pages: 1004-1013

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Handle: RePEc:eee:moneco:v:56:y:2009:i:7:p:1004-1013

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Web page: http://www.elsevier.com/locate/inca/505566

Related research

Keywords: Monetary search Imperfect information Welfare cost monetary cycles Welfare cost inflation;

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References

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  1. Miquel Faig & Belén Jerez, 2006. "Precautionary Balances and the Velocity of Circulation of Money," Working Papers tecipa-188, University of Toronto, Department of Economics.
  2. Lucas, Robert Jr., 1972. "Expectations and the neutrality of money," Journal of Economic Theory, Elsevier, vol. 4(2), pages 103-124, April.
  3. Irina A. Telyukova & Randall Wright, 2008. "A Model of Money and Credit, with Application to the Credit Card Debt Puzzle," Review of Economic Studies, Oxford University Press, vol. 75(2), pages 629-647.
  4. Guillaume Rocheteau & Randall Wright, 2004. "Money in search equilibrium, in competitive equilibrium, and in competitive search equilibrium," Working Paper 0405, Federal Reserve Bank of Cleveland.
  5. Klaus Adam, 2004. "Optimal Monetary Policy with Imperfect Common Knowledge," Econometric Society 2004 North American Winter Meetings 24, Econometric Society.
  6. Lucas, Robert E, Jr, 1973. "Some International Evidence on Output-Inflation Tradeoffs," American Economic Review, American Economic Association, vol. 63(3), pages 326-34, June.
  7. Katzman,B. & Kennan,J. & Wallace,N., 2001. "Output and price level effects of monetary uncertainty in a matching model," Working papers 1, Wisconsin Madison - Social Systems.
  8. Wallace, Neil, 1997. "Short-Run and Long-Run Effects of Changes in Money in a Random-Matching Model," Journal of Political Economy, University of Chicago Press, vol. 105(6), pages 1293-1307, December.
  9. Ricardo Lagos & Randall Wright, 2004. "A unified framework for monetary theory and policy analysis," Staff Report 346, Federal Reserve Bank of Minneapolis.
  10. Robert E. Lucas Jr., 2003. "Macroeconomic Priorities," American Economic Review, American Economic Association, vol. 93(1), pages 1-14, March.
  11. Christian Hellwig, 2004. "Heterogeneous Information and the Benefits of Public Information Disclosures (October 2005)," UCLA Economics Online Papers 283, UCLA Department of Economics.
  12. Lucas, Robert E, Jr, 1975. "An Equilibrium Model of the Business Cycle," Journal of Political Economy, University of Chicago Press, vol. 83(6), pages 1113-44, December.
  13. King, Robert G, 1982. "Monetary Policy and the Information Content of Prices," Journal of Political Economy, University of Chicago Press, vol. 90(2), pages 247-79, April.
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Cited by:
  1. Williamson, Stephen & Wright, Randall, 2010. "New Monetarist Economics: Models," Handbook of Monetary Economics, in: Benjamin M. Friedman & Michael Woodford (ed.), Handbook of Monetary Economics, edition 1, volume 3, chapter 2, pages 25-96 Elsevier.

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