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Inflation and Welfare with Search and Price Dispersion

Author

Listed:
  • Liang Wang

    (Department of Economics, University of Hawaii)

Abstract
This paper studies the effect of inflation on welfare in a monetary economy with price dispersion and consumer search. When facing greater price dispersion with higher inflation, consumers search harder for lower prices, and increased search raises welfare by intensifying market competition. Producers post inefficiently high prices, and this creates a welfare loss. Both mechanisms are affected by the consumer's monetary balance. I develop a general equilibrium model with search frictions to incorporate the interrelationship of money, search, and endogenous price dispersion. Inflation aspects welfare through three channels: the real balance channel, the search channel, and the price posting channel. I calibrate the model to U.S. data and find that the welfare cost of 10% annual inflation is worth 3.23% of consumption; however, if either the real balance or the price posting channel is closed, the welfare cost significantly decreases to less than 0.15% of consumption. The price posting channel amplifies the welfare-diminishing effect of the real balance channel, and the aggregated negative effect exceeds the positive effect due to the search channel. The search cost only generates a negligible welfare loss.

Suggested Citation

  • Liang Wang, 2011. "Inflation and Welfare with Search and Price Dispersion," Working Papers 201113, University of Hawaii at Manoa, Department of Economics.
    • Handle: RePEc:hai:wpaper:201113
    as

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    File URL: http://www.economics.hawaii.edu/research/workingpapers/WP_11-13.pdf
    File Function: First version, 2011
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    References listed on IDEAS

    as
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    More about this item

    Keywords

    Inflation; Interest Rates; Money; Price Dispersion; Search; Welfare;
    All these keywords.

    JEL classification:

    • E31 - Macroeconomics and Monetary Economics - - Prices, Business Fluctuations, and Cycles - - - Price Level; Inflation; Deflation
    • E40 - Macroeconomics and Monetary Economics - - Money and Interest Rates - - - General
    • E50 - Macroeconomics and Monetary Economics - - Monetary Policy, Central Banking, and the Supply of Money and Credit - - - General
    • D83 - Microeconomics - - Information, Knowledge, and Uncertainty - - - Search; Learning; Information and Knowledge; Communication; Belief; Unawareness

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