Welfare Cost of (Low) Inflation

This paper provides general equilibrium estimates of the steady-state welfare gains of lowering inflation from a low level to close to price stability, using an overlapping-generations growth model. Money demand is modeled on the basis that real money balances are a factor of production. Assuming a standard Fisher equation modified by the presence of an income tax, it is found that inflation unambiguously reduces capital intensity, drives up the before-tax real rate of return to capital, and unambiguously imposes a life-time welfare cost. This welfare cost is, however, quantitatively very modest (under 0.2 percent of GDP annually) within reasonable ranges of all parameter values.

Capital (architecture) · Deadweight loss · Econometrics · Economics · Fisher equation · General equilibrium theory · Inflation (cosmology) · Interest rate · Macroeconomics · Monetary economics · Overlapping generations model · Production (economics) · Real interest rate · Welfare · Economic theories and models · Economic Theory and Policy · Fiscal Policy and Economic Growth