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Avoiding the Inflation Tax

  • Huberto M. Ennis

    (Federal Reserve Bank of Richmond)

I study the effects of inflation on the purchasing behavior of buyers in an economy where money is essential for certain transactions (as in Lagos and Wright, 2005). A long-standing intuition in this subject is that when inflation increases, agents try to spend their money holdings more speedily. The standard framework fails to capture this kind of effect (Lagos and Rocheteau, 2005). I propose a simple modification of the model in which trading of goods and rebalancing of money holdings happen less frequently. In such a framework, I show that higher inflation induces buyers to search for transactions more intensively and buy goods of worse quality. The modification proposed also sheds new light on the connection between the search-theoretic and the inventory-theoretic models of money.

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Paper provided by Society for Economic Dynamics in its series 2007 Meeting Papers with number 493.

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Date of creation: 2007
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Handle: RePEc:red:sed007:493
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  1. Allen Head & Alok Kumar, 2004. "Price Dispersion, Inflation and Welfare," NajEcon Working Paper Reviews 122247000000000241, www.najecon.org.
  2. Aleksander Berentsen & Gabriele Camera & C hristopher W aller, 2005. "The Distribution Of Money Balances And The Nonneutrality Of Money," International Economic Review, Department of Economics, University of Pennsylvania and Osaka University Institute of Social and Economic Research Association, vol. 46(2), pages 465-487, 05.
  3. Li, Victor E, 1997. "The Efficiency of Monetary Exchange in Search Equilibrium," Journal of Money, Credit and Banking, Blackwell Publishing, vol. 29(1), pages 61-72, February.
  4. Trejos, Alberto & Wright, Randall, 1995. "Search, Bargaining, Money, and Prices," Journal of Political Economy, University of Chicago Press, vol. 103(1), pages 118-41, February.
  5. Tommasi, Mariano, 1999. "On high inflation and the allocation of resources," Journal of Monetary Economics, Elsevier, vol. 44(3), pages 401-421, December.
  6. Brian Peterson & Shouyong Shi, 2004. "Money, price dispersion and welfare," Economic Theory, Springer, vol. 24(4), pages 907-932, November.
  7. Randall Wright & Guillame Rocheteau, 2003. "Money in Search Equilibrium, in Competitive Equilibrium, and in Competitive Search Equilibrium," Levine's Bibliography 666156000000000302, UCLA Department of Economics.
  8. Ricardo Lagos & Randall Wright, 2002. "A unified framework for monetary theory and policy analysis," Working Paper 0211, Federal Reserve Bank of Cleveland.
  9. Christopher Waller & Guillaume Rocheteau, 2005. "Bargaining in Monetary Economies," 2005 Meeting Papers 55, Society for Economic Dynamics.
  10. Rubinstein, Ariel & Wolinsky, Asher, 1987. "Middlemen," The Quarterly Journal of Economics, MIT Press, vol. 102(3), pages 581-93, August.
  11. Jovanovic, Boyan, 1982. "Inflation and Welfare in the Steady State," Journal of Political Economy, University of Chicago Press, vol. 90(3), pages 561-77, June.
  12. Fernando Alvarez & Andrew Atkeson, 1996. "Money and Exchange Rates in the Grossman-Weiss-Rotemberg Model," NBER Working Papers 5678, National Bureau of Economic Research, Inc.
  13. Ricardo Lagos & Guillaume Rocheteau, 2004. "Inflation, output, and welfare," Working Paper 0407, Federal Reserve Bank of Cleveland.
  14. Miguel Molico, 2006. "The Distribution Of Money And Prices In Search Equilibrium," International Economic Review, Department of Economics, University of Pennsylvania and Osaka University Institute of Social and Economic Research Association, vol. 47(3), pages 701-722, 08.
  15. Guillaume Rocheteau & Christopher Waller, 2005. "Bargaining and the value of money," Working Paper 0501, Federal Reserve Bank of Cleveland.
  16. Pedro Teles & Ruilin Zhou, 2005. "A stable money demand: Looking for the right monetary aggregate," Economic Perspectives, Federal Reserve Bank of Chicago, issue Q I, pages 50-63.
  17. Thomas M. Humphrey, 1993. "The origins of velocity functions," Economic Quarterly, Federal Reserve Bank of Richmond, issue Fall, pages 1-18.
  18. Alberto Trejos, 1997. "Incentives to produce quality and the liquidity of money (*)," Economic Theory, Springer, vol. 9(2), pages 355-365.
  19. Cooley, T.F. & Hansen, G.D., 1988. "The Inflation Tax In A Real Business Cycle Model," Papers 88-05, Rochester, Business - General.
  20. Stephen Williamson, 2004. "Search, Limited Participation, and Monetary Policy," 2004 Meeting Papers 214, Society for Economic Dynamics.
  21. Chiu, Jonathan & Molico, Miguel, 2010. "Liquidity, redistribution, and the welfare cost of inflation," Journal of Monetary Economics, Elsevier, vol. 57(4), pages 428-438, May.
  22. Robert E. Lucas, Jr., 2000. "Inflation and Welfare," Econometrica, Econometric Society, vol. 68(2), pages 247-274, March.
  23. Li, Victor E, 1995. "The Optimal Taxation of Fiat Money in Search Equilibrium," International Economic Review, Department of Economics, University of Pennsylvania and Osaka University Institute of Social and Economic Research Association, vol. 36(4), pages 927-42, November.
  24. Chiu, Jonathan, 2014. "Endogenously Segmented Asset Market In An Inventory-Theoretic Model Of Money Demand," Macroeconomic Dynamics, Cambridge University Press, vol. 18(02), pages 438-472, March.
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