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Welfare Cost of (Low) Inflation: A General Equilibrium Perspective

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  • Howell H. Zee

Abstract

This paper provides general equilibrium estimates of the steady-state welfare gains of lowering inflation from a low level to close to price stability, using an overlapping-generations growth model. Money demand is modeled on the basis that real money balances are a factor of production. Assuming a standard Fisher equation modified by the presence of an income tax, it is found that inflation unambiguously reduces capital intensity, drives up the before-tax real rate of return to capital, and unambiguously imposes a life-time welfare cost. This welfare cost is, however, quantitatively very modest (under 0.2 percent of GDP annually) within reasonable ranges of all parameter values.

Suggested Citation

  • Howell H. Zee, 2000. "Welfare Cost of (Low) Inflation: A General Equilibrium Perspective," FinanzArchiv: Public Finance Analysis, Mohr Siebeck, Tübingen, vol. 57(4), pages 376-393, August.
  • Handle: RePEc:mhr:finarc:urn:sici:0015-2218(200108)57:4_376:wco(ia_2.0.tx_2-8
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    JEL classification:

    • D9 - Microeconomics - - Micro-Based Behavioral Economics
    • E4 - Macroeconomics and Monetary Economics - - Money and Interest Rates
    • H6 - Public Economics - - National Budget, Deficit, and Debt

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