The welfare cost of inflation in general equilibrium

https://doi.org/10.1016/0304-3932(95)01239-7Get rights and content

Abstract

This paper presents a general equilibrium monetary model in which inflation distorts a variety of marginal decisions. Although individually none of the distortions is very large, they combine to yield substantial welfare cost estimates. A sustained 4 percent inflation like that experienced in the US since 1983 costs the economy the equivalent of 0.41 percent of output per year when currency is identified as the relevant definition of money and over 1 percent of output per year when M1 is defined as money. The results illustrate how the traditional, partial equilibrium approach can seriously underestimate the true cost of inflation.

References (33)

  • M.J. Bailey

    The welfare cost of inflationary finance

    Journal of Political Economy

    (1956)
  • R. Benabou

    Comment on ‘The welfare costs of moderate inflations’

    Journal of Money, Credit, and Banking

    (1991)
  • R. Black et al.

    Non-superneutralities and some benefits of disinflation: A quantitative general equilibrium analysis

    (1993)
  • C.T. Carlstrom et al.

    Zero inflation: Transition costs and shoe leather benefits

    Contemporary Policy Issues

    (1993)
  • H.L. Cole et al.

    Specialization, transactions technologies, and money growth

    International Economic Review

    (1992)
  • W.J. Coleman

    Money, interest, and capital in a cash-in-advance economy

    (1993)
  • Cited by (0)

    ∗∗

    We would like to thank William English, Jeffrey Lacker, Robert Lucas, Kevin Reffett, Thomas Sargent, the referee, seminar participants at Duke University, the Federal Reserve Bank of Richmond, and the Swiss National Bank, and participants at the Federal Reserve System Conference on Business and Financial Analysis, September 1993, for their helpful comments and suggestions. The opinions expressed herein are our own and do not necessarily reflect those of the Federal Reserve Bank of Richmond or the Federal Reserve System.

    View full text