ON THE “HOT POTATO” EFFECT OF INFLATION: INTENSIVE VERSUS EXTENSIVE MARGINS

Lucy Qian Liu (), Liang Wang and Randall Wright

Macroeconomic Dynamics, 2011, vol. 15, issue S2, 191-216

Abstract: Conventional wisdom is that inflation makes people spend money faster, trying to get rid of it like a “hot potato,” and this is a channel through which inflation affects velocity and welfare. Monetary theory with endogenous search intensity seems ideal for studying this. However, in standard models, inflation is a tax that lowers the surplus from monetary exchange and hence reduces search effort. We replace search intensity with a free entry (participation) decision for buyers—i.e., we focus on the extensive rather than intensive margin—and prove buyers always spend their money faster when inflation increases. We also discuss welfare.

Date: 2011
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