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Avoiding the inflation tax

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  • Huberto M. Ennis

Abstract

I study the effects of inflation on the purchasing behavior of buyers in an economy where money is essential for certain transactions (as in Lagos and Wright, 2005). A long-standing intuition in this subject is that when inflation increases, agents try to spend their money holdings speedily. The standard framework fails to capture this kind of effect (see Lagos and Rocheteau, 2005). I propose a simple modification of the model that improves it in this dimension. I assume that buyers can rebalance their money holdings only sporadically (i.e., not every period). With this minimal change in the environment, I show that higher inflation induces some buyers to spend their money faster by frontloading their consumption, searching more intensively for transactions, and buying low-quality goods. In this way, the model is able to reproduce distortions in the pattern of transactions that, traditionally, have played an important role in the evaluation of the cost of inflation.

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Bibliographic Info

Paper provided by Federal Reserve Bank of Richmond in its series Working Paper with number 05-10.

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Date of creation: 2005
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Handle: RePEc:fip:fedrwp:05-10

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Keywords: Inflation (Finance) ; Money;

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References

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  1. Jonathan Chiu, 2007. "Endogenously Segmented Asset Market in an Inventory Theoretic Model of Money Demand," Working Papers 07-46, Bank of Canada.
  2. Fernando Alvarez & Andrew Atkeson, 1996. "Money and Exchange Rates in the Grossman-Weiss-Rotemberg Model," NBER Working Papers 5678, National Bureau of Economic Research, Inc.
  3. Allen Head & Alok Kumar, 2005. "Price Dispersion, Inflation, And Welfare," International Economic Review, Department of Economics, University of Pennsylvania and Osaka University Institute of Social and Economic Research Association, vol. 46(2), pages 533-572, 05.
  4. Jovanovic, Boyan, 1982. "Inflation and Welfare in the Steady State," Journal of Political Economy, University of Chicago Press, vol. 90(3), pages 561-77, June.
  5. Randall Wright & Guillame Rocheteau, 2003. "Money in Search Equilibrium, in Competitive Equilibrium, and in Competitive Search Equilibrium," Levine's Bibliography 666156000000000302, UCLA Department of Economics.
  6. Christopher Waller & Guillaume Rocheteau, 2005. "Bargaining in Monetary Economies," 2005 Meeting Papers 55, Society for Economic Dynamics.
  7. Ricardo Lagos & Randall Wright, 2004. "A unified framework for monetary theory and policy analysis," Staff Report 346, Federal Reserve Bank of Minneapolis.
  8. Thomas F. Cooley & Gary D. Hansen, 1987. "The Inflation Tax in a Real Business Cycle Model," UCLA Economics Working Papers 496, UCLA Department of Economics.
  9. Alberto Trejos, 1997. "Incentives to produce quality and the liquidity of money (*)," Economic Theory, Springer, vol. 9(2), pages 355-365.
  10. Brian Peterson & Shouyong Shi, 2004. "Money, price dispersion and welfare," Economic Theory, Springer, vol. 24(4), pages 907-932, November.
  11. 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.
  12. Jonathan Chiu & Miguel Molico, 2007. "Liquidity, Redistribution, and the Welfare Cost of Inflation," Working Papers 07-39, Bank of Canada.
  13. Pedro Teles & Ruilin Zhou, 2005. "A stable money demand: Looking for the right monetary aggregate," Economic Perspectives, Federal Reserve Bank of Chicago, issue Q I, pages 50-63.
  14. Thomas M. Humphrey, 1993. "The origins of velocity functions," Economic Quarterly, Federal Reserve Bank of Richmond, issue Fall, pages 1-18.
  15. Boragan Aruoba, S. & Rocheteau, Guillaume & Waller, Christopher, 2007. "Bargaining and the value of money," Journal of Monetary Economics, Elsevier, vol. 54(8), pages 2636-2655, November.
  16. Tommasi, Mariano, 1999. "On high inflation and the allocation of resources," Journal of Monetary Economics, Elsevier, vol. 44(3), pages 401-421, December.
  17. Robert E. Lucas, Jr., 2000. "Inflation and Welfare," Econometrica, Econometric Society, vol. 68(2), pages 247-274, March.
  18. Ricardo Lagos & Guillaume Rocheteau, 2004. "Inflation, output, and welfare," Working Paper 0407, Federal Reserve Bank of Cleveland.
  19. Aleksander Berentsen & Gabriele Camera & Christopher Waller, . "The Distribution of Money Balances and the Non-Neutrality of Money," IEW - Working Papers 220, Institute for Empirical Research in Economics - University of Zurich.
  20. Stephen D. Williamson, 2006. "Search, Limited Participation, And Monetary Policy ," International Economic Review, Department of Economics, University of Pennsylvania and Osaka University Institute of Social and Economic Research Association, vol. 47(1), pages 107-128, 02.
  21. 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.
  22. Trejos, Alberto & Wright, Randall, 1995. "Search, Bargaining, Money, and Prices," Journal of Political Economy, University of Chicago Press, vol. 103(1), pages 118-41, February.
  23. 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.
  24. Rubinstein, Ariel & Wolinsky, Asher, 1987. "Middlemen," The Quarterly Journal of Economics, MIT Press, vol. 102(3), pages 581-93, August.
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Citations

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Cited by:
  1. Williamson, Stephen D. & Wright, Randall, 2010. "New Monetarist Economics: Methods," MPRA Paper 21486, University Library of Munich, Germany.
  2. Chiu, Jonathan & Molico, Miguel, 2010. "Liquidity, redistribution, and the welfare cost of inflation," Journal of Monetary Economics, Elsevier, vol. 57(4), pages 428-438, May.
  3. Dong, Mei & Jiang, Janet Hua, 2014. "Money and price posting under private information," Journal of Economic Theory, Elsevier, vol. 150(C), pages 740-777.
  4. Ed Nosal & Christopher Waller & Randall Wright, 2010. "Introduction to the macroeconomic dynamics: special issues on money, credit, and liquidity," Working Paper Series WP-2010-14, Federal Reserve Bank of Chicago.
  5. Jonathan Chiu & Miguel Molico, 2011. "Uncertainty, Inflation, and Welfare," Journal of Money, Credit and Banking, Blackwell Publishing, vol. 43, pages 487-512, October.
  6. Lucy Qian Liu & Liang Wang & Randall Wright, 2009. "“On the ‘Hot Potato Effect’ of Inflation: Intensive versus Extensive Margins”," PIER Working Paper Archive 09-040, Penn Institute for Economic Research, Department of Economics, University of Pennsylvania.
  7. Cordelius Ilgmann, Martin Menner, . "Negative Nominal Interest Rates: History and Current Proposals," Working Papers 201143, Institute of Spatial and Housing Economics, Munster Universitary.

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