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Inflation and welfare: a search approach

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Author Info
Ben Craig
Guillaume Rocheteau

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Abstract

This paper extends recent findings in the search-theoretic literature on monetary exchange regarding the welfare costs of inflation. We present first estimates of the welfare cost of inflation using the "welfare triangle" methodology of Bailey (1958) and Lucas (2000). We then derive a money demand function from the search-theoretic model of Lagos and Wright (2005) and we estimate it from U.S. data over the period 1900-2000. We show that the welfare cost of inflation predicted by the model accords with the welfare-triangle measure when pricing mechanisms are such that buyers appropriate the social marginal benefit of their real balances. For other mechanisms, welfare triangles underestimate the true welfare cost of inflation because of a rent-sharing externality. We also point out other inefficiencies associated with noncompetitive pricing, which matter for estimating the cost of inflation. We then illustrate how endogenous participation decisions can mitigate or exacerbate the cost of inflation, and we provide calibrated examples in which a deviation from the Friedman rule is optimal. Finally, we discuss distributional effects of inflation.

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Article provided by Federal Reserve Bank of Cleveland in its journal Policy Discussion Papers.

Volume (Year): (2006)
Issue (Month): Jan ()
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Handle: RePEc:fip:fedcpd:y:2006:i:jan:n:12

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Keywords: Inflation (Finance)

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References listed on IDEAS
Please report citation or reference errors to , or , if you are the registered author of the cited work, log in to your RePEc Author Service profile, click on "citations" and make appropriate adjustments.:
  1. S. Boragan Aruoba & Randall Wright, 2003. "Search, money, and capital: a neoclassical dichotomy," Proceedings, Federal Reserve Bank of Cleveland, pages 1085-1117.
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  2. Miquel Faig, 2004. "Divisible Money in an Economy with Villages," Econometric Society 2004 North American Summer Meetings 248, Econometric Society. [Downloadable!]
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  3. Alexei Deviatov & Neil Wallace, 2001. "Another Example in which Lump-sum Money Creation is Beneficial," Advances in Macroeconomics, Berkeley Electronic Press, vol. 1(advances/), pages 1001-1001. [Downloadable!] (restricted)
  4. Lucas, Robert E., 1981. "Discussion of : Stanley Fischer, "towards an understanding of the costs of inflation: II"," Carnegie-Rochester Conference Series on Public Policy, Elsevier, vol. 15, pages 43-52. [Downloadable!] (restricted)
  5. Fischer, Stanley, 1981. "Towards an understanding of the costs of inflation: II," Carnegie-Rochester Conference Series on Public Policy, Elsevier, vol. 15, pages 5-41. [Downloadable!] (restricted)
  6. S. Rao Aiyagari & R. Anton Braun & Zvi Eckstein, 1998. "Transaction Services, Inflation, and Welfare," Journal of Political Economy, University of Chicago Press, vol. 106(6), pages 1274-1301, December. [Downloadable!] (restricted)
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  7. Robert E. Lucas, Jr., 2000. "Inflation and Welfare," Econometrica, Econometric Society, vol. 68(2), pages 247-274, March.
  8. Cooley, Thomas F & Hansen, Gary D, 1989. "The Inflation Tax in a Real Business Cycle Model," American Economic Review, American Economic Association, vol. 79(4), pages 733-48, September. [Downloadable!] (restricted)
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  9. Guillaume Rocheteau & Randall Wright, 2003. "Inflation and Welfare in Models with Trading Frictions," PIER Working Paper Archive 03-032, Penn Institute for Economic Research, Department of Economics, University of Pennsylvania. [Downloadable!]
  10. Shouyong Shi, 1997. "A Divisible Search Model of Fiat Money," Econometrica, Econometric Society, vol. 65(1), pages 75-102, January.
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  11. Cooley, Thomas F & Hansen, Gary D, 1991. "The Welfare Costs of Moderate Inflations," Journal of Money, Credit and Banking, Blackwell Publishing, vol. 23(3), pages 483-503, August. [Downloadable!] (restricted)
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  12. Ricardo Lagos & Randall Wright, 2002. "A unified framework for monetary theory and policy analysis," Working Paper 0211, Federal Reserve Bank of Cleveland. [Downloadable!]
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  13. Nash, John, 1950. "The Bargaining Problem," Econometrica, Econometric Society, vol. 18(2), pages 155-162, April. [Downloadable!] (restricted)
  14. Aleksander Berentsen & Guillaume Rocheteau & Shouyong Shi, 2007. "Friedman Meets Hosios: Efficiency in Search Models of Money," Economic Journal, Royal Economic Society, vol. 117(516), pages 174-195, 01. [Downloadable!] (restricted)
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  15. Kiyotaki, Nobuhiro & Wright, Randall, 1993. "A Search-Theoretic Approach to Monetary Economics," American Economic Review, American Economic Association, vol. 83(1), pages 63-77, March. [Downloadable!] (restricted)
  16. Hosios, Arthur J, 1990. "On the Efficiency of Matching and Related Models of Search and Unemployment," Review of Economic Studies, Blackwell Publishing, vol. 57(2), pages 279-98, April. [Downloadable!] (restricted)
  17. Kiyotaki, Nobuhiro & Wright, Randall, 1991. "A contribution to the pure theory of money," Journal of Economic Theory, Elsevier, vol. 53(2), pages 215-235, April. [Downloadable!] (restricted)
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  18. Li, Victor E, 1995. "The Optimal Taxation of Fiat Money in Search Equilibrium," International Economic Review, Department of Economics, University of Pennsylvania and Osaka University Institute of Social and Economic Research Association, vol. 36(4), pages 927-42, November. [Downloadable!] (restricted)
  19. Kiyotaki, Nobuhiro & Wright, Randall, 1989. "On Money as a Medium of Exchange," Journal of Political Economy, University of Chicago Press, vol. 97(4), pages 927-54, August. [Downloadable!] (restricted)
  20. Miguel Molico, 2006. "The Distribution Of Money And Prices In Search Equilibrium," International Economic Review, Department of Economics, University of Pennsylvania and Osaka University Institute of Social and Economic Research Association, vol. 47(3), pages 701-722, 08. [Downloadable!] (restricted)
  21. Ben R. Craig & Guillaume Rocheteau, 2005. "State-dependent pricing, inflation, and welfare in search economies," Working Paper 0504, Federal Reserve Bank of Cleveland. [Downloadable!]
  22. Li, Victor E, 1997. "The Efficiency of Monetary Exchange in Search Equilibrium," Journal of Money, Credit and Banking, Blackwell Publishing, vol. 29(1), pages 61-72, February.
  23. S. Boragan Aruoba & Christopher J. Waller, 2005. "Money and Capital," 2005 Meeting Papers 550, Society for Economic Dynamics. [Downloadable!]
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    • S. Boragan Aruoba & Christopher J. Waller & Randall Wright, 2007. "Money and capital," Working Paper 0714, Federal Reserve Bank of Cleveland. [Downloadable!]
  24. Guillaume Rocheteau & Randall Wright, 2003. "Money in Search Equilibrium, in Competitive Equilibrium, and in Competitive Search Equilibrium," PIER Working Paper Archive 03-031, Penn Institute for Economic Research, Department of Economics, University of Pennsylvania. [Downloadable!]
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  25. Guillaume Rocheteau & Christopher Waller, 2005. "Bargaining and the value of money," Working Paper 0501, Federal Reserve Bank of Cleveland. [Downloadable!]
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  26. Craig, Ben & Waller, C.J.Christopher J., 2004. "Dollarization and currency exchange," Journal of Monetary Economics, Elsevier, vol. 51(4), pages 671-689, May. [Downloadable!] (restricted)
  27. Dotsey, Michael & Ireland, Peter, 1996. "The welfare cost of inflation in general equilibrium," Journal of Monetary Economics, Elsevier, vol. 37(1), pages 29-47, February. [Downloadable!] (restricted)
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  28. Huberto M. Ennis, 2004. "Search, money, and inflation under private information," Discussion Paper / Institute for Empirical Macroeconomics 142, Federal Reserve Bank of Minneapolis. [Downloadable!]
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Full references

Cited by:
(explanations, Please report citation or reference errors to , or , if you are the registered author of the cited work, log in to your RePEc Author Service profile, click on "citations" and make appropriate adjustments.)

  1. Veronica Guerrieri & Guido Lorenzoni, 2007. "Liquidity and Trading Dynamics," NBER Working Papers 13204, National Bureau of Economic Research, Inc. [Downloadable!] (restricted)
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