State-dependent pricing, inflation, and welfare in search economies

Ben R. Craig and Guillaume Rocheteau ()

No 504, Working Paper from Federal Reserve Bank of Cleveland

Abstract: This paper investigates the welfare effects of inflation in economies with search frictions and menu costs. We first analyze an economy where there is no transaction demand for money balances: Money is a mere unit of account. We determine a condition under which price stability is optimal and a condition under which positive inflation is desirable. We relate these conditions to a standard efficiency condition for search economies. Second, we consider a related economy in which there is a transaction role for money. In the absence of menu costs, the Friedman rule is optimal. In the presence of menu costs, the optimal inflation rate is negative for all our numerical examples. A deviation from the Friedman rule can be optimal depending on the extent of the search externalities.

Keywords: Inflation (Finance); Money; Monetary policy (search for similar items in EconPapers)
New Economics Papers: this item is included in nep-cmp and nep-mon
Date: 2005
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Journal Article: State-dependent pricing, inflation, and welfare in search economies (2008)
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