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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. Jonathan Chiu, 2007. "Endogenously Segmented Asset Market in an Inventory Theoretic Model of Money Demand," Working Papers 07-46, Bank of Canada.
  2. 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.
  3. Shi Shouyong, 1997. "Search for a Monetary Propagation Mechanism," Working Papers 966, Queen's University, Department of Economics.
  4. Li, Victor E., 1994. "Inventory accumulation in a search-based monetary economy," Journal of Monetary Economics, Elsevier, vol. 34(3), pages 511-536, December.
  5. Aubhik Khan & Julia Thomas, 2007. "Inflation and interest rates with endogenous market segmentation," Working Papers 07-1, Federal Reserve Bank of Philadelphia.
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  7. Huberto M. Ennis, 2009. "Avoiding The Inflation Tax," International Economic Review, Department of Economics, University of Pennsylvania and Osaka University Institute of Social and Economic Research Association, vol. 50(2), pages 607-625, 05.
  8. Ricardo Lagos & Randall Wright, 2002. "A unified framework for monetary theory and policy analysis," Working Paper 0211, Federal Reserve Bank of Cleveland.
  9. Mei Dong & Janet Hua Jiang, 2011. "Money and Price Posting under Private Information," Working Papers 11-22, Bank of Canada.
  10. Dale Mortensen, 1984. "Job Search and Labor Market Analysis," Discussion Papers 594, Northwestern University, Center for Mathematical Studies in Economics and Management Science.
  11. 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.
  12. 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.
  13. Ricardo Lagos & Guillaume Rocheteau, 2005. "Inflation, Output, And Welfare," International Economic Review, Department of Economics, University of Pennsylvania and Osaka University Institute of Social and Economic Research Association, vol. 46(2), pages 495-522, 05.
  14. Nosal, Ed, 2011. "Search, Welfare, And The “Hot Potato” Effect Of Inflation," Macroeconomic Dynamics, Cambridge University Press, vol. 15(S2), pages 313-326, September.
  15. Shouyong Shi, 1996. "A Divisible Search Model of Fiat Money," Working Papers 930, Queen's University, Department of Economics.
  16. Guillaume Rocheteau & Randall Wright, 2005. "Money in Search Equilibrium, in Competitive Equilibrium, and in Competitive Search Equilibrium," Econometrica, Econometric Society, vol. 73(1), pages 175-202, 01.
  17. Chiu, Jonathan & Molico, Miguel, 2010. "Liquidity, redistribution, and the welfare cost of inflation," Journal of Monetary Economics, Elsevier, vol. 57(4), pages 428-438, May.
  18. Berentsen, Aleksander & Molico, Miguel & Wright, Randall, 2002. "Indivisibilities, Lotteries, and Monetary Exchange," Journal of Economic Theory, Elsevier, vol. 107(1), pages 70-94, November.
  19. Rupert, Peter & Schindler, Martin & Wright, Randall, 2001. "Generalized search-theoretic models of monetary exchange," Journal of Monetary Economics, Elsevier, vol. 48(3), pages 605-622, December.
  20. 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.
  21. 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.
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