Price Dispersion and the Costs of Inflation

33 Pages Posted: 20 Jul 2018

Date Written: June 29, 2018

Abstract

The new Keynesian literature typically makes the assumption that firms always have to satisfy demand. Because this assumption is at odds with profit-maximizing behavior under Calvo pricing when long-run inflation is positive, we present a new Keynesian model that relaxes this assumption. Our model predicts that inflation causes a substantially smaller loss in effective aggregate productivity compared to a benchmark model without the possibility of rationing. Moreover, under positive inflation, firms choose smaller markups over marginal costs in our model than in the benchmark model. As a result, our analysis suggests that the standard new Keynesian model may exaggerate the welfare costs of inflation. We also show that the effects are plausible to be quantitatively important.

Keywords: Trend Inflation, Optimal Inflation Target, New Keynesian Model, Welfare Costs of Inflation

JEL Classification: E31, E50

Suggested Citation

Hahn, Volker, Price Dispersion and the Costs of Inflation (June 29, 2018). Available at SSRN: https://ssrn.com/abstract=3205295 or http://dx.doi.org/10.2139/ssrn.3205295

Volker Hahn (Contact Author)

University of Konstanz ( email )

Box 143
Konstanz, 78457
Germany

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