On Skill Heterogeneity and Inflation
This paper examines the welfare costs of inflation within a dynamic general equilibrium framework that incorporates ex ante skill heterogeneity among workers. Money is introduced via a cash-in-advance constraint on the purchases of consumption. Numerical experiments based on a plausible parameterization of the model indicate that welfare costs of inflation relative to an optimal monetary policy decrease as skill heterogeneity increases. An implication of this feature is that a greater degree of skill heterogeneity would be associated with a greater tolerance for inflation, consequently implying a positive correlation between agent heterogeneity and inflation. We also conduct an empirical study based on a panel of several countries that lends some support to this hypothesis. If we focus on the experience of industrialized economies, the data finds supports a positive inflation-heterogeneity correlation. However, this is not true of less developed economies, in which the inflation heterogeneity correlation if found to be negative.
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