Role of Cash and Costs of Inflation for Different Income Groups in the U.S.

Abstract

Due to the adverse effects of the Great Recession, economic inequality has received much attention in the macroeconomic literature. While U.S. monetary policy set by the Federal Reserve does not seek to directly influence economic inequality by operating under the dual mandate, it has indirect consequences on economic inequality as well as important redistributional effects as transaction patterns and cash constraints are not evenly distributed for different income groups. We build a monetary growth model where money is introduced via a Cash-In-Advance (CIA) constraint. Our model successfully generates patterns of income, wealth, and earnings inequality in the U.S. and we use this framework to analyze the redistributional impact of long-run inflation. We observe significant redistributional effects as inflation acts as a regressive tax on consumption; it adversely affects households at the bottom of the income partition and benefits those at the top. This paper contributes to the recent and growing literature on the redistributive effects of monetary policy.

Keywords: Inflation; Redistribution; Inequality; Ex-ante Heterogeneity, Progressive taxation

JEL Classification: D31; E21; E31; E4; E52; H23