Inflation tax in the lab: a theoretical and experimental study of competitive search equilibrium with inflation

Nejat Anbarci (), Richard Dutu and Nick Feltovich

Journal of Economic Dynamics and Control, 2015, vol. 61, issue C, 17-33

Abstract: In this paper we measure the effect of the inflation tax on economic activity and welfare within a controlled setting. To do so, we develop a model of price posting and monetary exchange with inflation and finite populations. The model, which provides a game–theoretic foundation to Rocheteau and Wright (2005)׳s competitive search monetary equilibrium, is used to derive theoretical propositions regarding the effects of inflation in this environment, which we test with a laboratory experiment that closely implements the theoretical framework. We find that the inflation tax is harmful – with cash holdings, production and welfare all falling as inflation rises – and that its effect is relatively larger at low inflation rates than at higher rates. For instance, for inflation rates between 0% and 5%, welfare in the two markets we consider (2[seller]×2[buyer] and 3×2) falls by roughly 1 percent for each percentage–point rise in inflation, compared with 0.4 percent over the range from 5% to 30%. Our findings lead us to conclude that the impact of the inflation tax should not be underestimated, even under low inflation.

Keywords: Money; Directed search; Posted price; Welfare loss; Friction; Experiment (search for similar items in EconPapers)
JEL-codes: C90 E31 E40 (search for similar items in EconPapers)
Date: 2015
References: View references in EconPapers View complete reference list from CitEc
Citations: View citations in EconPapers (10)

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Persistent link: https://EconPapers.repec.org/RePEc:eee:dyncon:v:61:y:2015:i:c:p:17-33

DOI: 10.1016/j.jedc.2015.09.005

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