Inflation and Welfare with Search and Price Dispersion

Liang Wang

No 201113, Working Papers from University of Hawaii at Manoa, Department of Economics

Abstract: This paper studies the effect of inflation on welfare in a monetary economy with price dispersion and consumer search. When facing greater price dispersion with higher inflation, consumers search harder for lower prices, and increased search raises welfare by intensifying market competition. Producers post inefficiently high prices, and this creates a welfare loss. Both mechanisms are affected by the consumer's monetary balance. I develop a general equilibrium model with search frictions to incorporate the interrelationship of money, search, and endogenous price dispersion. Inflation aspects welfare through three channels: the real balance channel, the search channel, and the price posting channel. I calibrate the model to U.S. data and find that the welfare cost of 10% annual inflation is worth 3.23% of consumption; however, if either the real balance or the price posting channel is closed, the welfare cost significantly decreases to less than 0.15% of consumption. The price posting channel amplifies the welfare-diminishing effect of the real balance channel, and the aggregated negative effect exceeds the positive effect due to the search channel. The search cost only generates a negligible welfare loss.

Keywords: Inflation; Interest Rates; Money; Price Dispersion; Search; Welfare (search for similar items in EconPapers)
JEL-codes: D83 E31 E40 E50 (search for similar items in EconPapers)
Pages: 49 pages
Date: 2011-07-18
New Economics Papers: this item is included in nep-cba, nep-cis, nep-dge, nep-mac and nep-mon
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