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Credit Markets and the Welfare Costs of Inflation

  • Jose De Gregorio
  • Federico Sturzenegger

We construct a simple model in which high inflation imposes welfare costs because it affects the ability of the financial sector to screen between high and low cost producers. Consumers search for a low price and inflation reduces the incentives to search, resulting in an increase in the demand of high cost producers. We show that beyond a certain level of inflation there is a switch from a separating equilibrium to a pooling equilibrium, where financial institutions become unable to distinguish among clients. In this pooling equilibrium a larger share of credit is allocated to less efficient firms.

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File URL: http://www.nber.org/papers/w4873.pdf
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Paper provided by National Bureau of Economic Research, Inc in its series NBER Working Papers with number 4873.

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Date of creation: Oct 1994
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Publication status: Published as "Welfare Costs of Inflation, Seigniorage, and Financial Innovation", IMF, Vol. 38, no. 4 (1991): 675-704.
Handle: RePEc:nbr:nberwo:4873
Note: IFM
Contact details of provider: Postal: National Bureau of Economic Research, 1050 Massachusetts Avenue Cambridge, MA 02138, U.S.A.
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  1. Mariano Tommasi, 1992. "The Welfare Effects of Inflation, The Consequences of Price Instability on Search Markets," UCLA Economics Working Papers 655, UCLA Department of Economics.
  2. Benabou, Roland, 1988. "Search, Price Setting and Inflation," Review of Economic Studies, Wiley Blackwell, vol. 55(3), pages 353-76, July.
  3. Jose De Gregorio & Federico Sturzenegger, 1994. "Financial Markets and Inflation Under Imperfect Information," IMF Working Papers 94/63, International Monetary Fund.
  4. Stiglitz, Joseph E & Weiss, Andrew, 1981. "Credit Rationing in Markets with Imperfect Information," American Economic Review, American Economic Association, vol. 71(3), pages 393-410, June.
  5. Rudiger Dornbusch & Ferico Sturzenegger & Holger Wolf, 1990. "Extreme Inflation: Dynamics and Stabilization," Brookings Papers on Economic Activity, Economic Studies Program, The Brookings Institution, vol. 21(2), pages 1-84.
  6. Mariano Tommasi, 1993. "High Inflation: Resource Misallocations and Growth Effects," UCLA Economics Working Papers 704, UCLA Department of Economics.
  7. Casella, Alessandra & Feinstein, Jonathan S, 1990. "Economic Exchange during Hyperinflation," Journal of Political Economy, University of Chicago Press, vol. 98(1), pages 1-27, February.
  8. De Gregorio, Jose, 1993. "Inflation, taxation, and long-run growth," Journal of Monetary Economics, Elsevier, vol. 31(3), pages 271-298, June.
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