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Welfare Costs of Inflation and Imperfect Competition in a Monetary Search Model

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  • Benjamín García

Abstract

In this paper, I quantitatively measure the welfare costs of inflation. I build into standard moneysearch models, such as Rocheteau and Wright(2005) and Lagos and Wright(2005), by introducing endogenous imperfect competition based on free entry decisions that allow for the share of the transaction surplus going to firms to be determined endogenously. Under this framework, the welfare cost of inflation is amplified through a feedback loop, in which restricted money demand reduces the number of firms that the market can support. In turn, this reduction increases market concentration, reduces the consumer surplus, and further decreases the incentives to hold money. I find that, depending on the calibration, between 63 to 90 percent of the estimated welfare costs of inflation can be attributed to the interaction between money holdings and market concentration.

Suggested Citation

  • Benjamín García, 2016. "Welfare Costs of Inflation and Imperfect Competition in a Monetary Search Model," Working Papers Central Bank of Chile 794, Central Bank of Chile.
  • Handle: RePEc:chb:bcchwp:794
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    References listed on IDEAS

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    1. 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, January.
    2. Scott J. Dressler, 2011. "Money Holdings, Inflation, And Welfare In A Competitive Market," International Economic Review, Department of Economics, University of Pennsylvania and Osaka University Institute of Social and Economic Research Association, vol. 52(2), pages 407-423, May.
    3. Ben Craig & Guillaume Rocheteau, 2008. "Inflation and Welfare: A Search Approach," Journal of Money, Credit and Banking, Blackwell Publishing, vol. 40(1), pages 89-119, February.
    4. 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.
    5. Venky Venkateswaran & Randall Wright, 2014. "Pledgability and Liquidity: A New Monetarist Model of Financial and Macroeconomic Activity," NBER Macroeconomics Annual, University of Chicago Press, vol. 28(1), pages 227-270.
    6. Robert E. Lucas, Jr., 2000. "Inflation and Welfare," Econometrica, Econometric Society, vol. 68(2), pages 247-274, March.
    7. Milton Friedman & Anna J. Schwartz, 1982. "Monetary Trends in the United States and United Kingdom: Their Relation to Income, Prices, and Interest Rates, 1867–1975," NBER Books, National Bureau of Economic Research, Inc, number frie82-2, June.
    8. Wang, Weimin & Shi, Shouyong, 2006. "The variability of velocity of money in a search model," Journal of Monetary Economics, Elsevier, vol. 53(3), pages 537-571, April.
    9. Aruoba, S. Boragan & Waller, Christopher J. & Wright, Randall, 2011. "Money and capital," Journal of Monetary Economics, Elsevier, vol. 58(2), pages 98-116, March.
    10. Jonathan Chiu & Miguel Molico, 2011. "Uncertainty, Inflation, and Welfare," Journal of Money, Credit and Banking, Blackwell Publishing, vol. 43, pages 487-512, October.
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