Inflation, Price Dispersion, and Welfare: The Role of Consumer Search

85 Pages Posted: 10 Jun 2022 Last revised: 30 May 2024

Multiple version iconThere are 2 versions of this paper

Date Written: May 21, 2024

Abstract

In standard macroeconomic models, the costs of inflation are tightly linked to the price dispersion of identical goods. Therefore, understanding how price dispersion empirically relates to inflation is crucial for welfare analysis. In this paper, I study the relationship between steady-state inflation and price dispersion for a cross section of U.S. retail products using scanner data. By comparing prices of items with the same barcode, my measure of relative price dispersion controls for product heterogeneity, overcoming an important challenge in the literature. I document a new fact: price dispersion of identical goods increases steeply around zero inflation and becomes flatter as inflation increases, displaying a 𝚼-shaped pattern. Current sticky-price models are inconsistent with this finding. I develop a menu-cost model with idiosyncratic productivity shocks and sequential consumer search that reproduces the new fact and exhibits realistic price-setting behavior. In the model, inflation-induced price dispersion increases shoppers' incentives to search for low prices and thus competition among retailers. The positive welfare-maximizing inflation rate optimally trades off the efficiency gains from lower markups and the resources spent on search.

Keywords: Inflation, Welfare, Monetary Economics, Consumer Search

JEL Classification: E31, E50, L11, L16

Suggested Citation

Sara-Zaror, Francisca, Inflation, Price Dispersion, and Welfare: The Role of Consumer Search (May 21, 2024). Available at SSRN: https://ssrn.com/abstract=4127502 or http://dx.doi.org/10.2139/ssrn.4127502

Francisca Sara-Zaror (Contact Author)

Federal Reserve Board of Governors ( email )

Washington, D.C., DC

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