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The welfare costs of expected and unexpected inflation

  • Faig, Miquel
  • Li, Zhe

The monetary search model by Lagos and Wright (2005) is extended with imperfect information about nominal shocks as in Lucas (1972). An analytical solution exists with logarithmic preferences. In general, individuals hold precautionary balances. Calibrated to United States postwar data, the welfare cost of the monetary cycle is calculated to be small (below 0.0003% of GDP) compared to the welfare cost of the inflation tax (around 0.25% of GDP). The main reason for the minute welfare cost of the monetary cycle is its low amplitude in 1947-2007. But, monetary crashes, such as those experienced during the Great Depression, can generate important welfare costs.

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Article provided by Elsevier in its journal Journal of Monetary Economics.

Volume (Year): 56 (2009)
Issue (Month): 7 (October)
Pages: 1004-1013

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Handle: RePEc:eee:moneco:v:56:y:2009:i:7:p:1004-1013
Contact details of provider: Web page: http://www.elsevier.com/locate/inca/505566

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  1. Katzman, Brett & Kennan, John & Wallace, Neil, 2003. "Output and price level effects of monetary uncertainty in a matching model," Journal of Economic Theory, Elsevier, vol. 108(2), pages 217-255, February.
  2. 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.
  3. Miquel Faig & Belén Jerez, 2007. "Precautionary Balances and the Velocity of Circulation of Money," Journal of Money, Credit and Banking, Blackwell Publishing, vol. 39(4), pages 843-873, 06.
  4. Klaus Adam, 2004. "Optimal Monetary Policy with Imperfect Common Knowledge," Econometric Society 2004 North American Winter Meetings 24, Econometric Society.
  5. Irina A. Telyukova & Randall Wright, 2006. "A Model of Money and Credit, with Application to the Credit Card Debt Puzzle," 2006 Meeting Papers 45, Society for Economic Dynamics.
  6. Ricardo Lagos & Randall Wright, 2004. "A unified framework for monetary theory and policy analysis," Staff Report 346, Federal Reserve Bank of Minneapolis.
  7. Lucas, Robert Jr., 1972. "Expectations and the neutrality of money," Journal of Economic Theory, Elsevier, vol. 4(2), pages 103-124, April.
  8. King, Robert G, 1982. "Monetary Policy and the Information Content of Prices," Journal of Political Economy, University of Chicago Press, vol. 90(2), pages 247-79, April.
  9. Robert E. Lucas Jr., 2003. "Macroeconomic Priorities," American Economic Review, American Economic Association, vol. 93(1), pages 1-14, March.
  10. Lucas, Robert E, Jr, 1975. "An Equilibrium Model of the Business Cycle," Journal of Political Economy, University of Chicago Press, vol. 83(6), pages 1113-44, December.
  11. Lucas, Robert E, Jr, 1973. "Some International Evidence on Output-Inflation Tradeoffs," American Economic Review, American Economic Association, vol. 63(3), pages 326-34, June.
  12. Wallace, Neil, 1997. "Short-Run and Long-Run Effects of Changes in Money in a Random-Matching Model," Journal of Political Economy, University of Chicago Press, vol. 105(6), pages 1293-1307, December.
  13. Christian Hellwig, 2004. "Heterogeneous Information and the Benefits of Public Information Disclosures (October 2005)," UCLA Economics Online Papers 283, UCLA Department of Economics.
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