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The Misallocation of Resources of Anticipated Inflation

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  • Michael Frenkel

    (Koblenz School of Corporate Management)

  • Gil Mehrez

    (Georgetown University)

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    Abstract

    This paper analyzes the effects of anticipated inflation on the resource allocations between production and financial services. We develop a model with heterogeneous workers and two sectors economy. A manufacturing sector producing a final composite good and a financial sector providing monetary management services for manufacturers. Workers in this economy are heterogeneous in their productivity and are free to move between the two sectors. Hence workers with high productivity in the financial sector choose to work in the financial sector, where they can earn high wages, while workers with low productivity prefer to work in the manufacturing sector. In equilibrium, the allocation of workers between the two sectors, i.e., the size of each sector depends, among other factors, on the inflation rate. Higher inflation increases the marginal revenues of financial workers and decrease the marginal revenues of production workers. As a consequence, resources are shifted from the manufacturing sector to the financial sector. That is, the share of the financial services in output increases and production (output) decreases. The resulting decline in manufacturing sector output reduces consumption opportunities and represents costs of inflation. To estimate the change in the production structure and, thus, the costs of inflation we analyze data from 28 countries which had some notable inflation history during the period 1972-1995. We find strong support for the hypothesis that higher inflation increases the share of the financial sector output and employment relative to the manufacturing sector.

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    File URL: http://128.118.178.162/eps/mac/papers/9706/9706003.pdf
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    Bibliographic Info

    Paper provided by EconWPA in its series Macroeconomics with number 9706003.

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    Length: 27 pages
    Date of creation: 06 Jun 1997
    Date of revision:
    Handle: RePEc:wpa:wuwpma:9706003

    Note: Type of Document - WordPerfect; prepared on IBM PC ; to print on HP; pages: 27 ; figures: included
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    Web page: http://128.118.178.162

    Related research

    Keywords: anticipated inflation; resource allocation; financial sector.;

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    References

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    1. Lucas, Robert E, Jr, 1980. "Equilibrium in a Pure Currency Economy," Economic Inquiry, Western Economic Association International, vol. 18(2), pages 203-20, April.
    2. Stanley Fischer & Franco Modigliani, 1978. "Towards an understanding of the real effects and costs of inflation," Review of World Economics (Weltwirtschaftliches Archiv), Springer, vol. 114(4), pages 810-833, December.
    3. Cooley, Thomas F & Hansen, Gary D, 1991. "The Welfare Costs of Moderate Inflations," Journal of Money, Credit and Banking, Blackwell Publishing, vol. 23(3), pages 483-503, August.
    4. 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.
    5. Driffill, John & Mizon, Grayham Ernest & Ulph, Alistair Mitchell, 1989. "Costs of Inflation," CEPR Discussion Papers 293, C.E.P.R. Discussion Papers.
      • Driffill, John & Mizon, Grayham E. & Ulph, Alistair, 1990. "Costs of inflation," Handbook of Monetary Economics, in: B. M. Friedman & F. H. Hahn (ed.), Handbook of Monetary Economics, edition 1, volume 2, chapter 19, pages 1013-1066 Elsevier.
    6. Hahn, Frank, 1990. "On Inflation," Oxford Review of Economic Policy, Oxford University Press, vol. 6(4), pages 15-25, Winter.
    7. Robert E. Lucas Jr. & Nancy L. Stokey, 1984. "Money and Interest in Cash-In-Advance Economy," Discussion Papers 628, Northwestern University, Center for Mathematical Studies in Economics and Management Science.
    8. 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.
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