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Monetary exchange and the irreducible cost of inflation

Listed author(s):
  • Wong, Tsz-Nga

This paper applies a mechanism design approach to construct a lower bound to the welfare cost of inflation that does not depend on quasi-linear preferences or details of how agents trade. An incentive-feasible trading protocol is derived to minimize the welfare loss subject to frictions rendering money essential. The welfare cost of inflation under this optimal protocol is the lower bound over all pairwise trading protocols of monetary exchange. In general, the first-best is not implementable, even under the Friedman's rule, patient agents and the optimal mechanism. Thus, the lower bound depends on fundamentals like preferences and technology. Finally, I estimate the irreducible cost of 10% inflation with the U.S. data from 1900 to 2000.

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File URL: http://www.sciencedirect.com/science/article/pii/S0022053116000296
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Article provided by Elsevier in its journal Journal of Economic Theory.

Volume (Year): 164 (2016)
Issue (Month): C ()
Pages: 218-229

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Handle: RePEc:eee:jetheo:v:164:y:2016:i:c:p:218-229
DOI: 10.1016/j.jet.2016.02.008
Contact details of provider: Web page: http://www.elsevier.com/locate/inca/622869

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  1. Tai-wei Hu & John Kennan & Neil Wallace, 2009. "Coalition-Proof Trade and the Friedman Rule in the Lagos-Wright Model," Journal of Political Economy, University of Chicago Press, vol. 117(1), pages 116-137, 02.
  2. Ricardo Lagos & Randall Wright, 2005. "A Unified Framework for Monetary Theory and Policy Analysis," Journal of Political Economy, University of Chicago Press, vol. 113(3), pages 463-484, June.
  3. Guillaume Rocheteau & Pierre-Olivier Weill & Tsz-Nga Wong, 2015. "A Tractable Model of Monetary Exchange with Ex-post Heterogeneity," NBER Working Papers 21179, National Bureau of Economic Research, Inc.
  4. 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.
  5. 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.
  6. repec:oup:qjecon:v:129:y:2013:i:1:p:259-274 is not listed on IDEAS
  7. Zhu, Tao, 2008. "Equilibrium concepts in the large-household model," Theoretical Economics, Econometric Society, vol. 3(2), June.
  8. Rocheteau, Guillaume, 2012. "The cost of inflation: A mechanism design approach," Journal of Economic Theory, Elsevier, vol. 147(3), pages 1261-1279.
  9. Robert E. Lucas, Jr., 2000. "Inflation and Welfare," Econometrica, Econometric Society, vol. 68(2), pages 247-274, March.
  10. Chao Gu & Fabrizio Mattesini & Randall Wright, 2015. "Money and Credit Redux," Working Papers 1508, Department of Economics, University of Missouri.
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