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Uncertainty, Inflation, and Welfare

Author

Listed:
  • Jonathan Chiu
  • Miguel Molico
Abstract
This paper studies the welfare costs and the redistributive effects of inflation in the presence of idiosyncratic liquidity risk, in a micro-founded 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% smaller compared to a complete markets, representative agent economy, and that inflation induces important redistributive effects across households. For example, the welfare gains of reducing inflation from 10% to 0% is 0.59% of income. Furthermore, we estimate that the long-run welfare gains of reducing the typical current inflation target of 2 to 1 percent to be 0.06% of income.

Suggested Citation

  • Jonathan Chiu & Miguel Molico, 2008. "Uncertainty, Inflation, and Welfare," Staff Working Papers 08-13, Bank of Canada.
    • Handle: RePEc:bca:bocawp:08-13
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    References listed on IDEAS

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    More about this item

    Keywords

    Inflation: costs and benefits; Monetary policy framework;

    JEL classification:

    • 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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