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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.

Suggested Citation

  • Laurence Ball & David Romer, 1993. "Inflation and the Informativeness of Prices," NBER Working Papers 4267, National Bureau of Economic Research, Inc.
  • Handle: RePEc:nbr:nberwo:4267
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    References listed on IDEAS

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    More about this item

    JEL classification:

    • E31 - Macroeconomics and Monetary Economics - - Prices, Business Fluctuations, and Cycles - - - Price Level; Inflation; Deflation

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