Thursday, 25 March 2010: 14:50
Search-theoretic models of monetary exchange resurrect the view that welfare costs of inflation arise because the latter acts as a tax on money balances. In contrast with standard Calvo pricing models, empirical work on institutional features of the labor market shows that wage negotiations take place while expiring contracts are still in place, implying that wages are predetermined to future consumption and money holdings decisions. Bringing these seemingly unrelated aspects together in a stylized general equilibrium model, we identify a long-term trade-off between inflation and output. Model simulations suggest that a moderate long-run inflation rate generates non-negligible output gains.