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The welfare cost of inflation in general equilibrium

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Michael Dotsey
Peter Ireland

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Abstract

This paper presents a general equilibrium monetary model in which inflation distorts a variety of marginal decisions. Although individually none of the distortions is very large, they combine to yield substantial welfare cost estimates. A sustained 4% inflation like that experienced in the U.S. since 1983 costs the economy the equivalent of 0.41% of output per year when currency is identified as the relevant definition of money and over 1% of output per year when M1 is defined as money. The results illustrate how the traditional, partial equilibrium approach can seriously underestimate the true cost of inflation.

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Paper provided by Federal Reserve Bank of Richmond in its series Working Paper with number 94-04.

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Date of creation: 1994
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Handle: RePEc:fip:fedrwp:94-04

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Keywords: Inflation (Finance);

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References listed on IDEAS
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  1. Kormendi, Roger C. & Meguire, Philip G., 1985. "Macroeconomic determinants of growth: Cross-country evidence," Journal of Monetary Economics, Elsevier, vol. 16(2), pages 141-163, September. [Downloadable!] (restricted)
  2. Romer, Paul M, 1986. "Increasing Returns and Long-run Growth," Journal of Political Economy, University of Chicago Press, vol. 94(5), pages 1002-37, October. [Downloadable!] (restricted)
  3. Lucas, Robert Jr. & Stokey, Nancy L., 1983. "Optimal fiscal and monetary policy in an economy without capital," Journal of Monetary Economics, Elsevier, vol. 12(1), pages 55-93. [Downloadable!] (restricted)
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  4. Lacker, Jeffrey M. & Schreft, Stacey L., 1996. "Money and credit as means of payment," Journal of Monetary Economics, Elsevier, vol. 38(1), pages 3-23, August. [Downloadable!] (restricted)
  5. 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(1), pages 43-52, January. [Downloadable!] (restricted)
  6. Fischer, Stanley, 1981. "Towards an understanding of the costs of inflation: II," Carnegie-Rochester Conference Series on Public Policy, Elsevier, vol. 15(1), pages 5-41, January. [Downloadable!] (restricted)
  7. King, Robert G & Rebelo, Sergio T, 1993. "Transitional Dynamics and Economic Growth in the Neoclassical Model," American Economic Review, American Economic Association, vol. 83(4), pages 908-31, September. [Downloadable!] (restricted)
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  8. Ping Wang & Chong K. Yip, 1993. "Real effects of money and welfare costs of inflation in an endogenously growing economy with transactions costs," Research Paper 9311, Federal Reserve Bank of Dallas. [Downloadable!]
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  9. Cole, Harold L & Stockman, Alan C, 1992. "Specialization, Transactions Technologies, and Money Growth," International Economic Review, Department of Economics, University of Pennsylvania and Osaka University Institute of Social and Economic Research Association, vol. 33(2), pages 283-98, May. [Downloadable!] (restricted)
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  10. Charles T. Carlstrom & William T. Gavin, 1991. "Zero inflation: transition costs and shoe-leather benefits," Working Paper 9113, Federal Reserve Bank of Cleveland. [Downloadable!]
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  11. 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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  12. Wilbur John Coleman II, 1988. "Money, interest, and capital in a cash-in-advance economy," International Finance Discussion Papers 323, Board of Governors of the Federal Reserve System (U.S.). [Downloadable!]
  13. Marquis, M.H. & Reffett, K., 1992. "New Technology Spillovers into the Payment System," Working Papers 1992_04_2, Department of Economics, Florida State University.
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  14. Gillman, Max, 1993. "The welfare cost of inflation in a cash-in-advance economy with costly credit," Journal of Monetary Economics, Elsevier, vol. 31(1), pages 97-115, February. [Downloadable!] (restricted)
  15. Schreft, Stacey L., 1992. "Welfare-improving credit controls," Journal of Monetary Economics, Elsevier, vol. 30(1), pages 57-72, October. [Downloadable!] (restricted)
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  16. repec:fth:simfra:93-03 is not listed on IDEAS
  17. Imrohoroglu, Ayse, 1992. "The welfare cost of inflation under imperfect insurance," Journal of Economic Dynamics and Control, Elsevier, vol. 16(1), pages 79-91, January. [Downloadable!] (restricted)
  18. Gomme, P., 1993. "Money and Growth Revisited : Measuring the Costs of Inflation in an Endogenous Growth Model," Discussion Papers dp93-03, Department of Economics, Simon Fraser University.
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  19. Karni, Edi, 1974. "The Value of Time and the Demand for Money," Journal of Money, Credit and Banking, Blackwell Publishing, vol. 6(1), pages 45-64, February. [Downloadable!] (restricted)
  20. Larry E. Jones & Rodolfo E. Manuelli, 1993. "Growth and the Effects of Inflation," NBER Working Papers 4523, National Bureau of Economic Research, Inc. [Downloadable!] (restricted)
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  21. Levine, Ross & Renelt, David, 1992. "A Sensitivity Analysis of Cross-Country Growth Regressions," American Economic Review, American Economic Association, vol. 82(4), pages 942-63, September. [Downloadable!] (restricted)
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  22. De Gregorio, Jose, 1993. "Inflation, taxation, and long-run growth," Journal of Monetary Economics, Elsevier, vol. 31(3), pages 271-298, June. [Downloadable!] (restricted)
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