1. Inflation tax in the lab: a theoretical and experimental study of competitive search equilibrium with inflation
- Author
-
Richard Dutu, Nick Feltovich, and Nejat Anbarci
- Subjects
Macroeconomics ,Inflation ,Economics and Econometrics ,jel:C90 ,Control and Optimization ,Inflation targeting ,jel:E40 ,Applied Mathematics ,Producer Price Index (India) ,media_common.quotation_subject ,Monetary policy ,Monetary economics ,jel:E31 ,Inflation tax ,Economics ,Misery index ,money, inflation tax, directed search, posted prices, cash balances, welfare loss, frictions, experiment ,Real interest rate ,Indexation ,media_common - 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.
- Published
- 2015