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Incomplete markets and the output–inflation tradeoff

  • Yann Algan


  • Edouard Challe


  • Xavier Ragot


This paper analyses the effects of money shocks on macroeconomic aggregates in a flexible-price, incomplete-markets environment that generates persistent wealth inequalities amongst agents. In this framework, unexpected money shocks redistribute wealth from the cash-rich employed to the cash-poor unemployed, and induce the former to increase their labour supply in order to maintain their desired levels of consumption and precautionary savings. The reduced-form dynamics of the model is a textbook "output-inflation tradeoff" equation whereby inflation shocks raise current output. The attenuating role of mean inflation and money growth persistence on this non-neutrality tradeoff, as well as some of the welfare implications of wealth redistribution, are also examined.

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Article provided by Springer & Society for the Advancement of Economic Theory (SAET) in its journal Economic Theory.

Volume (Year): 46 (2011)
Issue (Month): 1 (January)
Pages: 55-84

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Handle: RePEc:spr:joecth:v:46:y:2011:i:1:p:55-84
DOI: 10.1007/s00199-009-0499-0
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