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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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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
Date of revision:
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
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  1. 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.
  2. Benabou, Roland, 1988. "Search, Price Setting and Inflation," Review of Economic Studies, Wiley Blackwell, vol. 55(3), pages 353-76, July.
  3. De Gregorio, Jose, 1993. "Inflation, taxation, and long-run growth," Journal of Monetary Economics, Elsevier, vol. 31(3), pages 271-298, June.
  4. Mariano Tommasi, 1993. "High Inflation: Resource Misallocations and Growth Effects," UCLA Economics Working Papers 704, UCLA Department of Economics.
  5. De Gregorio, Jose & Sturzenegger, Federico, 1997. "Financial markets and inflation under imperfect information," Journal of Development Economics, Elsevier, vol. 54(1), pages 149-168, October.
  6. 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.
  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. 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.
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