Inflation tax in the lab: a theoretical and experimental study of competitive search equilibrium with inflation

Anbarci, N.; Dutu, R.; Feltovich, N.

Abstract

In this paper we measure the effect of the inflation tax on economic activity and welfare within a controlled setting. To do so, we develop a model of price posting and monetary exchange with inflation and finite populations. The model, which provides a game–theoretic foundation to Rocheteau and Wright (2005)׳s competitive search monetary equilibrium, is used to derive theoretical propositions regarding the effects of inflation in this environment, which we test with a laboratory experiment that closely implements the theoretical framework. We find that the inflation tax is harmful – with cash holdings, production and welfare all falling as inflation rises – and that its effect is relatively larger at low inflation rates than at higher rates. For instance, for inflation rates between 0% and 5%, welfare in the two markets we consider (2[seller]×2[buyer] and 3×2) falls by roughly 1 percent for each percentage–point rise in inflation, compared with 0.4 percent over the range from 5% to 30%. Our findings lead us to conclude that the impact of the inflation tax should not be underestimated, even under low inflation.

Citation

Anbarci, N., Dutu, R., & Feltovich, N. (2015). Inflation tax in the lab: a theoretical and experimental study of competitive search equilibrium with inflation. Journal of Economic Dynamics and Control, 61, 17-33. https://doi.org/10.1016/j.jedc.2015.09.005

• Journal Article Type: Article
• Acceptance Date: Sep 9, 2015
• Online Publication Date: Sep 18, 2015
• Publication Date: Sep 18, 2015
• Deposit Date: Aug 16, 2018
• Publicly Available Date: Aug 29, 2018
• Journal: Journal of Economic Dynamics and Control
• Print ISSN: 0165-1889
• Electronic ISSN: 1879-1743
• Publisher: Elsevier
• Peer Reviewed: Peer Reviewed
• Volume: 61
• Pages: 17-33
• DOI: https://doi.org/10.1016/j.jedc.2015.09.005
• Public URL: https://durham-repository.worktribe.com/output/1322783