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Inflation tax in the lab: a theoretical and experimental study of competitive search equilibrium with inflation

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  • Anbarci, Nejat
  • Dutu, Richard
  • Feltovich, Nick

Abstract

In this paper we measure the effect of the inflation tax on economic activity and welfare within a controlled setting. To do so, we develop a model of price posting and monetary exchange with inflation and finite populations. The model, which provides a game–theoretic foundation to Rocheteau and Wright (2005)׳s competitive search monetary equilibrium, is used to derive theoretical propositions regarding the effects of inflation in this environment, which we test with a laboratory experiment that closely implements the theoretical framework. We find that the inflation tax is harmful – with cash holdings, production and welfare all falling as inflation rises – and that its effect is relatively larger at low inflation rates than at higher rates. For instance, for inflation rates between 0% and 5%, welfare in the two markets we consider (2[seller]×2[buyer] and 3×2) falls by roughly 1 percent for each percentage–point rise in inflation, compared with 0.4 percent over the range from 5% to 30%. Our findings lead us to conclude that the impact of the inflation tax should not be underestimated, even under low inflation.

Suggested Citation

  • Anbarci, Nejat & Dutu, Richard & Feltovich, Nick, 2015. "Inflation tax in the lab: a theoretical and experimental study of competitive search equilibrium with inflation," Journal of Economic Dynamics and Control, Elsevier, vol. 61(C), pages 17-33.
  • Handle: RePEc:eee:dyncon:v:61:y:2015:i:c:p:17-33
    DOI: 10.1016/j.jedc.2015.09.005
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    Cited by:

    1. Douglas Davis & Oleg Korenok & Peter Norman & Bruno Sultanum & Randall Wright, 2019. "Playing with Money," Working Paper 19-2, Federal Reserve Bank of Richmond.
    2. Aurélien Nioche & Basile Garcia & Germain Lefebvre & Thomas Boraud & Nicolas P. Rougier & Sacha Bourgeois-Gironde, 2019. "Coordination over a unique medium of exchange under information scarcity," Palgrave Communications, Palgrave Macmillan, vol. 5(1), pages 1-11, December.
    3. John Duffy & Daniela Puzzello, 2019. "The Friedman Rule in the Laboratory," 2019 Meeting Papers 541, Society for Economic Dynamics.
    4. Nejat Anbarci & Nick Feltovich, 2018. "Pricing in Competitive Search Markets: The Roles of Price Information and Fairness Perceptions," Management Science, INFORMS, vol. 64(3), pages 1101-1120, March.

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    More about this item

    Keywords

    Money; Directed search; Posted price; Welfare loss; Friction; Experiment;
    All these keywords.

    JEL classification:

    • E31 - Macroeconomics and Monetary Economics - - Prices, Business Fluctuations, and Cycles - - - Price Level; Inflation; Deflation
    • E40 - Macroeconomics and Monetary Economics - - Money and Interest Rates - - - General
    • C90 - Mathematical and Quantitative Methods - - Design of Experiments - - - General

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