“On the ‘Hot Potato Effect’ of Inflation: Intensive versus Extensive Marginsâ€

Lucy Qian Liu (), Liang Wang and Randall Wright

PIER Working Paper Archive from Penn Institute for Economic Research, Department of Economics, University of Pennsylvania

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 endoge- nous 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.

Keywords: Search; Money; Inflation; Velocity; Free Entry (search for similar items in EconPapers)
JEL-codes: E31 E40 E50 (search for similar items in EconPapers)
Pages: 42 pages
Date: 2009-11-04
New Economics Papers: this item is included in nep-cba, nep-dge, nep-mic and nep-mon
References: View references in EconPapers View complete reference list from CitEc
Citations: View citations in EconPapers (12)

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Persistent link: https://EconPapers.repec.org/RePEc:pen:papers:09-040

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