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The Misallocation of Resources of Anticipated Inflation

  • Michael Frenkel

    (Koblenz School of Corporate Management)

  • Gil Mehrez

    (Georgetown University)

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    This paper analyzes the effects of anticipated inflation on the resource allocations between production and financial services. We develop a model with heterogeneous workers and two sectors economy. A manufacturing sector producing a final composite good and a financial sector providing monetary management services for manufacturers. Workers in this economy are heterogeneous in their productivity and are free to move between the two sectors. Hence workers with high productivity in the financial sector choose to work in the financial sector, where they can earn high wages, while workers with low productivity prefer to work in the manufacturing sector. In equilibrium, the allocation of workers between the two sectors, i.e., the size of each sector depends, among other factors, on the inflation rate. Higher inflation increases the marginal revenues of financial workers and decrease the marginal revenues of production workers. As a consequence, resources are shifted from the manufacturing sector to the financial sector. That is, the share of the financial services in output increases and production (output) decreases. The resulting decline in manufacturing sector output reduces consumption opportunities and represents costs of inflation. To estimate the change in the production structure and, thus, the costs of inflation we analyze data from 28 countries which had some notable inflation history during the period 1972-1995. We find strong support for the hypothesis that higher inflation increases the share of the financial sector output and employment relative to the manufacturing sector.

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    File URL: http://128.118.178.162/eps/mac/papers/9706/9706003.pdf
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    Paper provided by EconWPA in its series Macroeconomics with number 9706003.

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    Length: 27 pages
    Date of creation: 06 Jun 1997
    Date of revision:
    Handle: RePEc:wpa:wuwpma:9706003
    Note: Type of Document - WordPerfect; prepared on IBM PC ; to print on HP; pages: 27 ; figures: included
    Contact details of provider: Web page: http://128.118.178.162

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    1. Cooley, T.F. & Hansen, G.D., 1988. "The Inflation Tax In A Real Business Cycle Model," Papers 88-05, Rochester, Business - General.
    2. Driffill, John & Mizon, Grayham E. & Ulph, Alistair, 1990. "Costs of inflation," Handbook of Monetary Economics, in: B. M. Friedman & F. H. Hahn (ed.), Handbook of Monetary Economics, edition 1, volume 2, chapter 19, pages 1013-1066 Elsevier.
    3. Lucas, Robert E, Jr, 1980. "Equilibrium in a Pure Currency Economy," Economic Inquiry, Western Economic Association International, vol. 18(2), pages 203-20, April.
    4. Lucas, Robert E, Jr & Stokey, Nancy L, 1987. "Money and Interest in a Cash-in-Advance Economy," Econometrica, Econometric Society, vol. 55(3), pages 491-513, May.
    5. Thomas F. Cooley & Gary D. Hansen, 1991. "The welfare costs of moderate inflations," Proceedings, Federal Reserve Bank of Cleveland, pages 483-518.
    6. Hahn, Frank, 1990. "On Inflation," Oxford Review of Economic Policy, Oxford University Press, vol. 6(4), pages 15-25, Winter.
    7. Stanley Fischer & Franco Modigliani, 1978. "Towards an understanding of the real effects and costs of inflation," Review of World Economics (Weltwirtschaftliches Archiv), Springer, vol. 114(4), pages 810-833, December.
    8. 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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