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On The “Hot Potato” Effect Of Inflation: Intensive Versus Extensive Margins

  • Liu, Lucy Qian
  • Wang, Liang
  • Wright, Randall

Conventional wisdom is that inflation makes people spend money faster, trying to get rid of it like a “hot potato,” and this is a channel through which inflation affects velocity and welfare. Monetary theory with endogenous search intensity seems ideal for studying this. However, in standard models, inflation is a tax that lowers the surplus from monetary exchange and hence reduces search effort. We replace search intensity with a free entry (participation) decision for buyers—i.e., we focus on the extensive rather than intensive margin—and prove buyers always spend their money faster when inflation increases. We also discuss welfare.

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Article provided by Cambridge University Press in its journal Macroeconomic Dynamics.

Volume (Year): 15 (2011)
Issue (Month): S2 (September)
Pages: 191-216

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Handle: RePEc:cup:macdyn:v:15:y:2011:i:s2:p:191-216_00
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  1. S. Boragan Aruoba & Christopher J. Waller & Randall Wright, 2009. "Money and capital: a quantitative analysis," Working Papers 2009-031, Federal Reserve Bank of St. Louis.
  2. Ricardo Lagos & Guillaume Rocheteau, 2004. "Inflation, output, and welfare," Working Paper 0407, Federal Reserve Bank of Cleveland.
  3. Dong, Mei & Jiang, Janet Hua, 2014. "Money and price posting under private information," Journal of Economic Theory, Elsevier, vol. 150(C), pages 740-777.
  4. Edward J. Green & Ruilin Zhou, . ""A Rudimentary Model of Search with Divisible Money and Prices''," CARESS Working Papres 95-17, University of Pennsylvania Center for Analytic Research and Economics in the Social Sciences.
  5. Guillaume Rocheteau & Randall Wright, 2004. "Money in search equilibrium, in competitive equilibrium, and in competitive search equilibrium," Working Paper 0405, Federal Reserve Bank of Cleveland.
  6. Julia Thomas & Aubhik Khan, 2012. "Inflation and Interest Rates with Endogenous Market Segmentation," 2012 Meeting Papers 1070, Society for Economic Dynamics.
  7. Huberto M. Ennis, 2007. "Avoiding the inflation tax," Working Paper 07-06, Federal Reserve Bank of Richmond.
  8. Li, Victor E., 1994. "Inventory accumulation in a search-based monetary economy," Journal of Monetary Economics, Elsevier, vol. 34(3), pages 511-536, December.
  9. Jonathan Chiu & Miguel Molico, 2007. "Liquidity, Redistribution, and the Welfare Cost of Inflation," Working Papers 07-39, Bank of Canada.
  10. Miguel Molico, 2006. "The Distribution Of Money And Prices In Search Equilibrium," International Economic Review, Department of Economics, University of Pennsylvania and Osaka University Institute of Social and Economic Research Association, vol. 47(3), pages 701-722, 08.
  11. Nosal, Ed, 2011. "Search, Welfare, And The “Hot Potato” Effect Of Inflation," Macroeconomic Dynamics, Cambridge University Press, vol. 15(S2), pages 313-326, September.
  12. Shi, Shouyong, 1998. "Search for a Monetary Propagation Mechanism," Journal of Economic Theory, Elsevier, vol. 81(2), pages 314-352, August.
  13. Dale Mortensen, 1984. "Job Search and Labor Market Analysis," Discussion Papers 594, Northwestern University, Center for Mathematical Studies in Economics and Management Science.
  14. Jonathan Chiu, 2007. "Endogenously Segmented Asset Market in an Inventory Theoretic Model of Money Demand," Working Papers 07-46, Bank of Canada.
  15. Hosios, Arthur J, 1990. "On the Efficiency of Matching and Related Models of Search and Unemployment," Review of Economic Studies, Wiley Blackwell, vol. 57(2), pages 279-98, April.
  16. Ricardo Lagos & Randall Wright, 2004. "A unified framework for monetary theory and policy analysis," Staff Report 346, Federal Reserve Bank of Minneapolis.
  17. Peter Rupert & Martin Schindler & Randall Wright, 2000. "Generalized search-theoretic models of monetary exchange," Working Paper 0005, Federal Reserve Bank of Cleveland.
  18. Shouyong Shi, 1997. "A Divisible Search Model of Fiat Money," Econometrica, Econometric Society, vol. 65(1), pages 75-102, January.
  19. Robert E. Lucas, Jr., 2000. "Inflation and Welfare," Econometrica, Econometric Society, vol. 68(2), pages 247-274, March.
  20. Li, Victor E, 1995. "The Optimal Taxation of Fiat Money in Search Equilibrium," International Economic Review, Department of Economics, University of Pennsylvania and Osaka University Institute of Social and Economic Research Association, vol. 36(4), pages 927-42, November.
  21. Berentsen, Aleksander & Molico, Miguel & Wright, Randall, 2002. "Indivisibilities, Lotteries, and Monetary Exchange," Journal of Economic Theory, Elsevier, vol. 107(1), pages 70-94, November.
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