Working Paper
State-dependent pricing, inflation, and welfare in search economies
Abstract: This paper investigates the welfare effects of inflation in economies with search frictions and menu costs. We first analyze an economy where there is no transaction demand for money balances: Money is a mere unit of account. We determine a condition under which price stability is optimal and a condition under which positive inflation is desirable. We relate these conditions to a standard efficiency condition for search economies. Second, we consider a related economy in which there is a transaction role for money. In the absence of menu costs, the Friedman rule is optimal. In the presence of menu costs, the optimal inflation rate is negative for all our numerical examples. A deviation from the Friedman rule can be optimal depending on the extent of the search externalities.
Keywords: Inflation (Finance); Money; Monetary policy;
https://doi.org/10.26509/frbc-wp-200504
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Provider: Federal Reserve Bank of Cleveland
Part of Series: Working Papers (Old Series)
Publication Date: 2005
Number: 0504