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The Welfare Cost of Expected and Unexpected Inflation

  • Zhe Li

    (University of Toronto)

  • Miquel Faig

    (University of Toronto)

The monetary search model by Lagos and Wright (2005) is extended with imperfect information about nominal shocks à la Lucas (1972 and 1973). This framework is useful to estimate the welfare costs of expected and erratic inflation because it provides an avenue to identify the transactions affected by monetary shocks and how tolerant individuals are to the fluctuations of output in these transactions. We find that the welfare gain of eliminating the United States monetary business cycle observed from 1892 to 2005 is 0.01 percent of GDP while the welfare gain of reducing the observed average rate of inflation to the Friedman rule is 0.26 per cent of GDP, that is almost two orders of magnitude higher.

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Paper provided by Society for Economic Dynamics in its series 2007 Meeting Papers with number 125.

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Date of creation: 2007
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Handle: RePEc:red:sed007:125
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  1. Christian Hellwig, 2004. "Heterogeneous Information and the Benefits of Public Information Disclosures (October 2005)," UCLA Economics Online Papers 283, UCLA Department of Economics.
  2. Irina A. Telyukova & Randall Wright, 2006. "A Model of Money and Credit, with Application to the Credit Card Debt Puzzle," 2006 Meeting Papers 45, Society for Economic Dynamics.
  3. Klaus Adam, 2004. "Optimal Monetary Policy with Imperfect Common Knowledge," Econometric Society 2004 North American Winter Meetings 24, Econometric Society.
  4. Lucas, Robert Jr., 1972. "Expectations and the neutrality of money," Journal of Economic Theory, Elsevier, vol. 4(2), pages 103-124, April.
  5. Guillaume Rocheteau & Randall Wright, 2004. "Money in search equilibrium, in competitive equilibrium, and in competitive search equilibrium," Working Paper 0405, Federal Reserve Bank of Cleveland.
  6. Ricardo Lagos & Randall Wright, 2002. "A unified framework for monetary theory and policy analysis," Working Paper 0211, Federal Reserve Bank of Cleveland.
  7. Miquel Faig & Belén Jerez, 2005. "Precautionary Balances And The Velocity Of Circulation Of Money," Economics Working Papers we051406, Universidad Carlos III, Departamento de Economía.
  8. Katzman,B. & Kennan,J. & Wallace,N., 2001. "Output and price level effects of monetary uncertainty in a matching model," Working papers 1, Wisconsin Madison - Social Systems.
  9. Lucas, Robert E, Jr, 1973. "Some International Evidence on Output-Inflation Tradeoffs," American Economic Review, American Economic Association, vol. 63(3), pages 326-34, June.
  10. King, Robert G, 1982. "Monetary Policy and the Information Content of Prices," Journal of Political Economy, University of Chicago Press, vol. 90(2), pages 247-79, April.
  11. Lucas, Robert E, Jr, 1975. "An Equilibrium Model of the Business Cycle," Journal of Political Economy, University of Chicago Press, vol. 83(6), pages 1113-44, December.
  12. Wallace, Neil, 1997. "Short-Run and Long-Run Effects of Changes in Money in a Random-Matching Model," Journal of Political Economy, University of Chicago Press, vol. 105(6), pages 1293-1307, December.
  13. Robert E. Lucas Jr., 2003. "Macroeconomic Priorities," American Economic Review, American Economic Association, vol. 93(1), pages 1-14, March.
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