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Credit Markets and the Welfare Costs of Inflation

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  • Jose De Gregorio
  • Federico Sturzenegger

Abstract

We construct a simple model in which high inflation imposes welfare costs because it affects the ability of the financial sector to screen between high and low cost producers. Consumers search for a low price and inflation reduces the incentives to search, resulting in an increase in the demand of high cost producers. We show that beyond a certain level of inflation there is a switch from a separating equilibrium to a pooling equilibrium, where financial institutions become unable to distinguish among clients. In this pooling equilibrium a larger share of credit is allocated to less efficient firms.

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Bibliographic Info

Paper provided by National Bureau of Economic Research, Inc in its series NBER Working Papers with number 4873.

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Date of creation: Oct 1994
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Publication status: Published as "Welfare Costs of Inflation, Seigniorage, and Financial Innovation", IMF, Vol. 38, no. 4 (1991): 675-704.
Handle: RePEc:nbr:nberwo:4873

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  1. 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.
  2. Stiglitz, Joseph E & Weiss, Andrew, 1981. "Credit Rationing in Markets with Imperfect Information," American Economic Review, American Economic Association, American Economic Association, vol. 71(3), pages 393-410, June.
  3. Benabou, Roland, 1988. "Search, Price Setting and Inflation," Review of Economic Studies, Wiley Blackwell, Wiley Blackwell, vol. 55(3), pages 353-76, July.
  4. Rudiger Dornbusch & Ferico Sturzenegger & Holger Wolf, 1990. "Extreme Inflation: Dynamics and Stabilization," Brookings Papers on Economic Activity, Economic Studies Program, The Brookings Institution, vol. 21(2), pages 1-84.
  5. De Gregorio, Jose, 1993. "Inflation, taxation, and long-run growth," Journal of Monetary Economics, Elsevier, Elsevier, vol. 31(3), pages 271-298, June.
  6. José De Gregorio & Federico Sturzenegger, 1997. "Financial Markets and Inflation under Imperfect Information," Documentos de Trabajo, Centro de Economía Aplicada, Universidad de Chile 23, Centro de Economía Aplicada, Universidad de Chile.
  7. Casella, Alessandra & Feinstein, Jonathan S, 1990. "Economic Exchange during Hyperinflation," Journal of Political Economy, University of Chicago Press, University of Chicago Press, vol. 98(1), pages 1-27, February.
  8. Mariano Tommasi, 1993. "High Inflation: Resource Misallocations and Growth Effects," UCLA Economics Working Papers, UCLA Department of Economics 704, UCLA Department of Economics.
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Citations

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Cited by:
  1. Bruno, Michael & Easterly, William, 1998. "Inflation crises and long-run growth," Journal of Monetary Economics, Elsevier, Elsevier, vol. 41(1), pages 3-26, February.
  2. Andres, Javier & Hernando, Ignacio & Lopez-Salido, J. David, 2004. "The role of the financial system in the growth-inflation link: the OECD experience," European Journal of Political Economy, Elsevier, Elsevier, vol. 20(4), pages 941-961, November.
  3. Qayyum, Abdul & Siddiqui, Rehana & Hanif, Muhammad Nadim, 2004. "Financial Development and Economic Growth: Evidence from Heterogeneous Panel Data of Low Income Countries," MPRA Paper 23431, University Library of Munich, Germany.
  4. Ciżkowicz, Piotr & Rzońca, Andrzej, 2013. "Does inflation harm corporate investment? Empirical evidence from OECD countries," Economics - The Open-Access, Open-Assessment E-Journal, Kiel Institute for the World Economy, Kiel Institute for the World Economy, vol. 7(16), pages 1-38.
  5. De Gregorio, Jose & Sturzenegger, Federico, 1997. "Financial markets and inflation under imperfect information," Journal of Development Economics, Elsevier, Elsevier, vol. 54(1), pages 149-168, October.
  6. Jones, L.E. & Manuelli, R.E, 1997. "Policy Uncertainty and Informational Monopolies: The Case of Monetary Policy," Working papers, Wisconsin Madison - Social Systems 9715, Wisconsin Madison - Social Systems.
  7. A.R. Kemal & Abdul Qayyum & Muhammad Nadim Hanif, 2007. "Financial Development and Economic Growth: Evidence from a Heterogeneous Panel of High Income Countries," Lahore Journal of Economics, Department of Economics, The Lahore School of Economics, Department of Economics, The Lahore School of Economics, vol. 12(1), pages 1-34, Jan-Jun.
  8. Jorge E. Restrepo L. & Luis Salomó S. & Rodrigo O. Valdés P., 2009. "Macroeconomy, Monetary Policy and Central Bank Capitalization," Journal Economía Chilena (The Chilean Economy), Central Bank of Chile, Central Bank of Chile, vol. 12(1), pages 5-38, April.
  9. Ciżkowicz, Piotr & Rzońca, Andrzej, 2010. "Inflation and corporate investment in selected OECD countries in the years 1960-2005 – an empirical analysis," MPRA Paper 29846, University Library of Munich, Germany.
  10. Tommasi, Mariano, 1999. "On high inflation and the allocation of resources," Journal of Monetary Economics, Elsevier, Elsevier, vol. 44(3), pages 401-421, December.

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