We analyze the welfare cost of inflation in a model with cash-in-advance constraints and an endogenous distribution of establishments` productivities. Inflation distorts aggregate productivity through firm entry dynamics. The model is calibrated to the United States economy and the long-run equilibrium properties are compared at low and high inflation. We find that, when the period over which the cash-in-advance constraint is binding is one quarter, an annual inflation rate of 10 percent leads to a decrease in the steady-state average productivity of roughly 0.5 percent compared to the optimum`s steady-state. This decrease in productivity is not innocuous: it leads to a doubling of the welfare cost of inflation.

Alexandre Janiak

Paulo Santos Monteiro

Publicado en: Journal of Money, Credit and Banking, 2011, Vol. 43, Iss. 5, pp. 795-834.

Keywords: Inflation and welfare in long-run equilibrium with firm dynamics