The Welfare Cost of Inflation in General Equilibrium
Federal Reserve Bank of Philadelphia
Peter N. Ireland
Boston College - Department of Economics; National Bureau of Economic Research (NBER)
This paper presents a general equilibrium monetary model in which inflation distorts a variety of marginal decisions. Although individually none of the distortions is very large, they combine to yield substantial welfare cost estimates. A sustained 4 percent inflation like that experienced in the US since 1983 costs the economy the equivalent of 0.41 percent of output per year when currency is identified as the relevant definition of money and over 1 percent of output per year when M1 is defined as money. The results illustrate how the traditional, partial equilibrium approach can seriously underestimate the true cost of inflation.
JEL Classification: E31
Date posted: October 2, 1999