Calculating Welfare Costs of Inflation in a Search Model with Preference Heterogeneity: A Calibration Exercise
Using U.S. cross-sectional data, this paper calculates the welfare cost of a 10% inflation for different individuals and finds that the difference in cost between the poorest 10%, measured by their expenditure share on cash goods, and the richest 10% is in the order of 176%. That is, a poor person is on average willing to forgive 176% more of their total consumption in order to have inflation reduced from 10% to 0. In absolute terms this represents a cost of 2.687% of consumption for the poorest and 0.974% for the richest. I accomplish this by introducing preference heterogeneity in a monetary search model first developed by Lagos and Wright (2005), and calibrate the model to match the expenditure share on cash goods and total expenditures for each individual type using data from the Consumer Expenditure Survey (CEX) for the second quarter of 1996. I also show that this welfare difference increases to 210% (10.522% for the poorest 10% and 3.401% for the richest 10%) whenever frictions in the use of money are imposed (holdup problem). The ability to explicitly model these frictions is the advantage of using this model. Hence, inflation in this framework, as other studies have shown, acts as a regressive consumption tax; and this regressiveness is augmented with the holdup problem.
|Date of creation:||Apr 2008|
|Contact details of provider:|| Postal: 812-855-1021|
Web page: http://www.iub.edu/~caepr
More information through EDIRC
Please report citation or reference errors to , or , if you are the registered author of the cited work, log in to your RePEc Author Service profile, click on "citations" and make appropriate adjustments.:
- Joydeep Bhattacharya & Joseph H. Haslag & Antoine Martin, 2005.
"Heterogeneity, Redistribution, And The Friedman Rule,"
International Economic Review,
Department of Economics, University of Pennsylvania and Osaka University Institute of Social and Economic Research Association, vol. 46(2), pages 437-454, 05.
- Joydeep Bhattacharya & Joseph H. Haslag & Antoine Martin, 2004. "Heterogeneity, redistribution, and the Friedman rule," Research Working Paper RWP 04-01, Federal Reserve Bank of Kansas City.
- Bhattacharya, Joydeep & Haslag, Joseph & Martin, Antoine, 2004. "Heterogeneity, Redistribution, and the Friedman Rule," Staff General Research Papers Archive 11371, Iowa State University, Department of Economics.
- Casey B. Mulligan & Xavier Sala-i-Martin, 2000. "Extensive Margins and the Demand for Money at Low Interest Rates," Journal of Political Economy, University of Chicago Press, vol. 108(5), pages 961-991, October.
- Erosa, Andres & Ventura, Gustavo, 2002.
"On inflation as a regressive consumption tax,"
Journal of Monetary Economics,
Elsevier, vol. 49(4), pages 761-795, May.
- Fischer, Stanley, 1981. "Towards an understanding of the costs of inflation: II," Carnegie-Rochester Conference Series on Public Policy, Elsevier, vol. 15(1), pages 5-41, January.
- Wu, Yangru & Zhang, Junxi, 2000. "Monopolistic competition, increasing returns to scale, and the welfare costs of inflation," Journal of Monetary Economics, Elsevier, vol. 46(2), pages 417-440, October.
- Cooley, T.F. & Hansen, G.D., 1988.
"The Inflation Tax In A Real Business Cycle Model,"
RCER Working Papers
155, University of Rochester - Center for Economic Research (RCER).
- Ricardo Lagos & Randall Wright, 2004.
"A unified framework for monetary theory and policy analysis,"
346, Federal Reserve Bank of Minneapolis.
- 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.
- Ricardo Lagos & Randall Wright, 2002. "A unified framework for monetary theory and policy analysis," Working Paper 0211, Federal Reserve Bank of Cleveland.
- Brock, William A, 1974. "Money and Growth: The Case of Long Run Perfect Foresight," International Economic Review, Department of Economics, University of Pennsylvania and Osaka University Institute of Social and Economic Research Association, vol. 15(3), pages 750-777, October.
- Easterly, William & Fischer, Stanley, 2000.
"Inflation and the poor,"
Policy Research Working Paper Series
2335, The World Bank.
- Lucas, Robert E., 1981. "Discussion of : Stanley Fischer, "towards an understanding of the costs of inflation: II"," Carnegie-Rochester Conference Series on Public Policy, Elsevier, vol. 15(1), pages 43-52, January.
- Kiyotaki, Nobuhiro & Wright, Randall, 1989. "On Money as a Medium of Exchange," Journal of Political Economy, University of Chicago Press, vol. 97(4), pages 927-954, August.
- Arthur B. Kennickell & Martha Starr-McCluer & Annika E. Sunden, 1997. "Family finances in the U.S.: recent evidence from the Survey of Consumer Finances," Federal Reserve Bulletin, Board of Governors of the Federal Reserve System (U.S.), issue Jan, pages 1-24.
- Nash, John, 1950. "The Bargaining Problem," Econometrica, Econometric Society, vol. 18(2), pages 155-162, April.
When requesting a correction, please mention this item's handle: RePEc:inu:caeprp:2008-012. See general information about how to correct material in RePEc.
For technical questions regarding this item, or to correct its authors, title, abstract, bibliographic or download information, contact: (Center for Applied Economics and Policy Research)
If references are entirely missing, you can add them using this form.