On Skill Heterogeneity and Inflation

Radhika Lahiri () and Elisabetta Magnani

No 181, School of Economics and Finance Discussion Papers and Working Papers Series from School of Economics and Finance, Queensland University of Technology

Abstract: This paper examines the welfare costs of inflation within a dynamic general equilibrium framework that incorporates ex ante skill heterogeneity among workers. Money is introduced via a cash-in-advance constraint on the purchases of consumption. Numerical experiments based on a plausible parameterization of the model indicate that welfare costs of inflation relative to an optimal monetary policy decrease as skill heterogeneity increases. An implication of this feature is that a greater degree of skill heterogeneity would be associated with a greater tolerance for inflation, consequently implying a positive correlation between agent heterogeneity and inflation. We also conduct an empirical study based on a panel of several countries that lends some support to this hypothesis. If we focus on the experience of industrialized economies, the data finds supports a positive inflation-heterogeneity correlation. However, this is not true of less developed economies, in which the inflation heterogeneity correlation if found to be negative.

Date: 2004-05-01
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