Working Paper

On the welfare cost of inflation


Abstract: Estimates are provided for the social cost of inflation in the U.S. economy. The estimated cost, expressed as a fraction of income, is proportional to the square root of the nominal interest rate. This approximation assigns much higher costs to low rates of inflation than does the familiar welfare triangle formula. ; These estimates are rationalized using Sidrauski's model, in which real balances yield utility, and also using the McCallum-Goodfriend model, in which real balances and time are combined via a transactions technology to support a given spending flow. The latter formulation is related to the Baumol and Miller-Orr inventory-theoretic models of money demand. Second-best modifications to take into account fiscal complications are also considered, but turn out to be quantitatively minor.

Keywords: Inflation (Finance); Monetary policy;

Status: Published in Conference on Monetary Policy in a Low Inflation Regime

Authors

Bibliographic Information

Provider: Federal Reserve Bank of San Francisco

Part of Series: Working Papers in Applied Economic Theory

Publication Date: 1994

Number: 94-07