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Nonlinear unemployment effects of the inflation tax

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  • Mohammed Ait Lahcen
  • Garth Baughman
  • Stanislav Rabinovich
  • Hugo van Buggenum

Abstract

We argue that long-run inflation has nonlinear and state-dependent e ects on unemployment, output, and welfare. Using panel data from the OECD, we document three correlations. First, there is a positive long-run relationship between anticipated inflation and unemployment. Second, there is also a positive correlation between anticipated inflation and unemployment volatility. Third, the long-run inflation-unemployment relationship is not only positive, but also stronger when unemployment is higher. We show that these correlations arise in a standard monetary search model with two shocks - productivity and monetary - and frictions in labor and goods markets. Inflation lowers the surplus from a worker-firm match, in turn making it sensitive to productivity shocks or to further increases in inflation. We calibrate the model to match the US postwar labor market and monetary data and show that it is consistent with observed cross-country correlations. The model implies that the welfare cost of inflation is nonlinear in the level of inflation and is amplified by the presence of aggregate shocks.

Suggested Citation

  • Mohammed Ait Lahcen & Garth Baughman & Stanislav Rabinovich & Hugo van Buggenum, 2021. "Nonlinear unemployment effects of the inflation tax," ECON - Working Papers 390, Department of Economics - University of Zurich.
  • Handle: RePEc:zur:econwp:390
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    More about this item

    Keywords

    Money; search; inflation; unemployment; unemployment volatility; fundamental surplus; product-labor market interaction;
    All these keywords.

    JEL classification:

    • E24 - Macroeconomics and Monetary Economics - - Consumption, Saving, Production, Employment, and Investment - - - Employment; Unemployment; Wages; Intergenerational Income Distribution; Aggregate Human Capital; Aggregate Labor Productivity
    • E30 - Macroeconomics and Monetary Economics - - Prices, Business Fluctuations, and Cycles - - - General (includes Measurement and Data)
    • E40 - Macroeconomics and Monetary Economics - - Money and Interest Rates - - - General
    • E50 - Macroeconomics and Monetary Economics - - Monetary Policy, Central Banking, and the Supply of Money and Credit - - - General

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