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Inflation and the Informativeness of Prices

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  • Laurence Ball
  • David Romer

Abstract

This paper studies the welfare effects of the relative price variability arising from inflation. When agents interact in anonymous markets, with customers buying from new suppliers each period, relative price variability benefits customers and cannot harm suppliers substantially. But if customers and suppliers form long-term relationships, prices have an informational role: a potential customer uses current prices as signals of future prices. Inflation reduces the informativeness of current prices, causing customers to make costly mistakes about which relationships to enter. In addition, the reduced informativeness of prices makes demand less price-elastic, thereby increasing markups. Both effects can be quantitatively significant at moderate inflation rates.

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Bibliographic Info

Paper provided by National Bureau of Economic Research, Inc in its series NBER Working Papers with number 4267.

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Date of creation: Jan 1993
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Publication status: published as Ball, Lawrence and N. Gregory Mankiw, "Interpreting the Correlation Between Inflation and the Skewness of Relative Prices: A Comment on Bryan and Cecchetti," Review of Economics and Statistics, Vol. 81, no. 2 (May 1999): 197-198.
Handle: RePEc:nbr:nberwo:4267

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  1. Anil K. Kashyap, 1990. "Sticky prices: new evidence from retail catalogs," Finance and Economics Discussion Series, Board of Governors of the Federal Reserve System (U.S.) 112, Board of Governors of the Federal Reserve System (U.S.).
  2. Stanley Fischer, 1981. "Relative Shocks, Relative Price Variability, and Inflation," Brookings Papers on Economic Activity, Economic Studies Program, The Brookings Institution, vol. 12(2), pages 381-442.
  3. Roland Benabou & Robert Gertner, 1991. "The Informativeness of Prices: Search With Learning and Cost Uncertainty," NBER Working Papers 3833, National Bureau of Economic Research, Inc.
  4. Roland Benabou & Jerzy Konieczny, 1993. "On Inflation and Output with Costly Price Changes: A Simple Unifying Result," NBER Technical Working Papers 0135, National Bureau of Economic Research, Inc.
  5. Mariano Tommasi, 1992. "The Welfare Effects of Inflation, The Consequences of Price Instability on Search Markets," UCLA Economics Working Papers, UCLA Department of Economics 655, UCLA Department of Economics.
  6. Peter A. Diamond, 1988. "Search, Sticky Prices, and Inflation," Working papers, Massachusetts Institute of Technology (MIT), Department of Economics 509, Massachusetts Institute of Technology (MIT), Department of Economics.
  7. Cecchetti, Stephen G., 1986. "The frequency of price adjustment : A study of the newsstand prices of magazines," Journal of Econometrics, Elsevier, Elsevier, vol. 31(3), pages 255-274, April.
  8. Naish, Howard F, 1986. "Price Adjustment Costs and the Output-Inflation Trade-off," Economica, London School of Economics and Political Science, London School of Economics and Political Science, vol. 53(210), pages 219-30, May.
  9. Michael L. Wachter & Oliver E. Williamson, 1978. "Obligational Markets and the Mechanics of Inflation," Bell Journal of Economics, The RAND Corporation, The RAND Corporation, vol. 9(2), pages 549-571, Autumn.
  10. Arthur M. Okun, 1975. "Inflation: Its Mechanics and Welfare Costs," Brookings Papers on Economic Activity, Economic Studies Program, The Brookings Institution, vol. 6(2), pages 351-402.
  11. Dennis W. Carlton, 1982. "The Disruptive Effect of Inflation on the Organization of Markets," NBER Chapters, in: Inflation: Causes and Effects, pages 139-152 National Bureau of Economic Research, Inc.
  12. Lucas, Robert E, Jr, 1973. "Some International Evidence on Output-Inflation Tradeoffs," American Economic Review, American Economic Association, American Economic Association, vol. 63(3), pages 326-34, June.
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