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Uncertainty, Inflation, and Welfare

Authors


  • We have benefited from the comments and suggestions from Gabriele Camera, James Chapman, Scott Dressler, Walter Engert, Huberto Ennis, Per Krusell, Cesaire Meh, Cyril Monnet, Yasuo Terajima, Randall Wright, and from participants at the “Liquidity and Frictional Markets” conference at the Cleveland Fed, the CEA Meetings in Halifax, the CMSG Meeting in Ottawa, the Far Eastern Econometric Society Meeting in Taipei, the Midwest Macroeconomics Conference in Cleveland, the Society of Economics Dynamics Conference in Prague, and the Workshop on “Optimal Monetary Policy and Central Bank Communication” in Switzerland. The views expressed in the paper are those of the authors. No responsibility for them should be attributed to the Bank of Canada.

Abstract

This paper studies the welfare costs and the redistributive effects of inflation in the presence of idiosyncratic liquidity risk, in a microfounded search-theoretical monetary model. We calibrate the model to match the empirical aggregate money demand and the distribution of money holdings across households and study the effects of inflation under the implied degree of market incompleteness. We show that in the presence of imperfect insurance the estimated long-run welfare costs of inflation are on average 40% to 55% smaller compared to a complete markets, representative agent economy, and that inflation induces important redistributive effects across households.

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