Inflation and Welfare in Long-Run Equilibrium with Firm Dynamics

Authors


  • The authors thank Riccardo DiCecio, Julia Thomas, and two anonymous referees for useful comments and suggestions which contributed to improve the paper. We have also benefited from the comments of seminar participants at ECARES, Federal Reserve Bank of St. Louis, University of Minho, University of Warwick, University of Exeter, PUC Chile and at the 2009 Latin American Econometric Society Meetings. All remaining errors are our own. Alexandre Janiak thanks Fondecyt for financial support (Project No. 11080251).

Abstract

We analyze the welfare cost of inflation in a model with a cash-in-advance constraint and an endogenous distribution of establishments' productivities. Inflation distorts aggregate productivity through firm entry dynamics. The model is calibrated to the U.S. economy and the long-run equilibrium properties are compared at low and high inflation. When the period over which the cash-in-advance constraint is binding is one quarter, an annual inflation rate of 10% leads to a decrease in average productivity of roughly 0.5% compared to the optimum. This decrease is not innocuous: it leads to a doubling of the welfare cost of inflation.

Ancillary