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Inflation, output and welfare

  • Ricardo Lagos
  • Guillaume Rocheteau

This paper studies the effects of anticipated inflation on aggregate output and welfare within a search-theoretic framework. We allow money-holders to choose the intensities with which they search for trading partners, so inflation affects the frequency of trade as well as the quantity of output produced in each trade. We consider the standard pricing mechanism for search models, i.e., ex post bargaining, as well as a notion of competitive pricing. If prices are bargained over, the equilibrium is generically inefficient and an increase in inflation reduces buyers? search intensities, output and welfare. If prices are posted and buyers can direct their search, search intensities are increasing with inflation for low inflation rates and decreasing for high inflation rates. The Friedman Rule achieves the first-best allocation and inflation always reduces welfare even though it can have a positive effect on output for low inflation rates.

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Paper provided by Federal Reserve Bank of Minneapolis in its series Staff Report with number 342.

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Date of creation: 2004
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Publication status: Published in International Economic Review> (Vol. 46, No. 2, May 2005, pp. 495-522)
Handle: RePEc:fip:fedmsr:342
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  1. Aleksander Berentsen & Guillaume Rocheteau & Shouyong Shi, 2007. "Friedman Meets Hosios: Efficiency in Search Models of Money," Economic Journal, Royal Economic Society, vol. 117(516), pages 174-195, 01.
  2. Moen, E.R., 1995. "Competitive Search Equilibrium," Memorandum 37/1995, Oslo University, Department of Economics.
  3. Ricardo Lagos & Randall Wright, 2002. "Dynamics, cycles and sunspot equilibria in "genuinely dynamic, fundamentally disaggregative" models of money," Working Paper 0210, Federal Reserve Bank of Cleveland.
  4. Nobuhiro Kiyotaki & Randall Wright, 1989. "A contribution to the pure theory of money," Staff Report 123, Federal Reserve Bank of Minneapolis.
  5. Li, Victor E, 1995. "The Optimal Taxation of Fiat Money in Search Equilibrium," International Economic Review, Department of Economics, University of Pennsylvania and Osaka University Institute of Social and Economic Research Association, vol. 36(4), pages 927-42, November.
  6. Bullard, James & Keating, John W., 1995. "The long-run relationship between inflation and output in postwar economies," Journal of Monetary Economics, Elsevier, vol. 36(3), pages 477-496, December.
  7. Lucas, Robert Jr. & Prescott, Edward C., 1974. "Equilibrium search and unemployment," Journal of Economic Theory, Elsevier, vol. 7(2), pages 188-209, February.
  8. Derek Laing & Victor E. Li & Ping Wang, 2000. "Inflation, trade frictions, and productive activity in a multiple-matching model of money," Working Paper 2000-28, Federal Reserve Bank of Atlanta.
  9. Kocherlakota, Narayana R., 1998. "Money Is Memory," Journal of Economic Theory, Elsevier, vol. 81(2), pages 232-251, August.
  10. Green, Edward J. & Zhou, Ruilin, 1998. "A Rudimentary Random-Matching Model with Divisible Money and Prices," Journal of Economic Theory, Elsevier, vol. 81(2), pages 252-271, August.
  11. Ricardo Lagos & Randall Wright, 2004. "A unified framework for monetary theory and policy analysis," Staff Report 346, Federal Reserve Bank of Minneapolis.
  12. Robert G. King & Mark W. Watson, 1992. "Testing long run neutrality," Working Paper Series, Macroeconomic Issues 92-18, Federal Reserve Bank of Chicago.
  13. Shouyong Shi, 1996. "A Divisible Search Model of Fiat Money," Working Papers 930, Queen's University, Department of Economics.
  14. Randall Wright & Guillame Rocheteau, 2003. "Money in Search Equilibrium, in Competitive Equilibrium, and in Competitive Search Equilibrium," Levine's Bibliography 666156000000000302, UCLA Department of Economics.
  15. Lucas, Robert E, Jr, 1996. "Nobel Lecture: Monetary Neutrality," Journal of Political Economy, University of Chicago Press, vol. 104(4), pages 661-82, August.
  16. Berentsen, Aleksander & Rocheteau, Guillaume, 2002. "On the efficiency of monetary exchange: how divisibility of money matters," Journal of Monetary Economics, Elsevier, vol. 49(8), pages 1621-1649, November.
  17. Rapach, David E, 2003. " International Evidence on the Long-Run Impact of Inflation," Journal of Money, Credit and Banking, Blackwell Publishing, vol. 35(1), pages 23-48, February.
  18. 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.
  19. Shouyong Shi, 1995. "Money and Prices: A Model of Search and Bargaining," Working Papers 916, Queen's University, Department of Economics.
  20. Robert E. Lucas, Jr., 2000. "Inflation and Welfare," Econometrica, Econometric Society, vol. 68(2), pages 247-274, March.
  21. Trejos, Alberto & Wright, Randall, 1995. "Search, Bargaining, Money, and Prices," Journal of Political Economy, University of Chicago Press, vol. 103(1), pages 118-41, February.
  22. Hosios, Arthur J, 1990. "On the Efficiency of Matching and Related Models of Search and Unemployment," Review of Economic Studies, Wiley Blackwell, vol. 57(2), pages 279-98, April.
  23. Kiyotaki, Nobuhiro & Wright, Randall, 1993. "A Search-Theoretic Approach to Monetary Economics," American Economic Review, American Economic Association, vol. 83(1), pages 63-77, March.
  24. Li, Victor E, 1997. "The Efficiency of Monetary Exchange in Search Equilibrium," Journal of Money, Credit and Banking, Blackwell Publishing, vol. 29(1), pages 61-72, February.
  25. Kiyotaki, Nobuhiro & Wright, Randall, 1989. "On Money as a Medium of Exchange," Journal of Political Economy, University of Chicago Press, vol. 97(4), pages 927-54, August.
  26. James Bullard, 1999. "Testing long-run monetary neutrality propositions: lessons from the recent research," Review, Federal Reserve Bank of St. Louis, issue Nov, pages 57-77.
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