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On Skill Heterogeneity and Inflation


  • Radhika Lahiri
  • Elisabetta Magnani


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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  • Radhika Lahiri & Elisabetta Magnani, 2004. "On Skill Heterogeneity and Inflation," School of Economics and Finance Discussion Papers and Working Papers Series 181, School of Economics and Finance, Queensland University of Technology.
  • Handle: RePEc:qut:dpaper:181

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    References listed on IDEAS

    1. Galor, Oded & Tsiddon, Daniel, 1997. "The Distribution of Human Capital and Economic Growth," Journal of Economic Growth, Springer, vol. 2(1), pages 93-124, March.
    2. Cukierman, Alex & Webb, Steven B, 1995. "Political Influence on the Central Bank: International Evidence," World Bank Economic Review, World Bank Group, vol. 9(3), pages 397-423, September.
    3. Cukierman, Alex & Webb, Steven B & Neyapti, Bilin, 1992. "Measuring the Independence of Central Banks and Its Effect on Policy Outcomes," World Bank Economic Review, World Bank Group, vol. 6(3), pages 353-398, September.
    4. Bell, Linda A. & Freeman, Richard B., 2001. "The incentive for working hard: explaining hours worked differences in the US and Germany," Labour Economics, Elsevier, vol. 8(2), pages 181-202, May.
    5. Glomm, Gerhard & Ravikumar, B, 1992. "Public versus Private Investment in Human Capital Endogenous Growth and Income Inequality," Journal of Political Economy, University of Chicago Press, vol. 100(4), pages 818-834, August.
    6. Casey B. Mulligan & Xavier Sala-i-Martin, 1995. "Adoption of financial technologies: Implications for money demand and monetary policy," Economics Working Papers 134, Department of Economics and Business, Universitat Pompeu Fabra.
    7. 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.
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