Understanding the distributional impact of long-run inflation

By Gabriele Camera and YiLi Chien

http://d.repec.org/n?u=RePEc:fip:fedlwp:2012-058&r=dge

The impact of fully anticipated inflation is systematically studied in heterogeneous agent economies with an endogenous labor supply and portfolio choices. In stationary equilibrium, inflation nonlinearly alters the endogenous distributions of income, wealth, and consumption. Small departures from zero inflation have the strongest impact. Three features determine how inflation impacts distributions and welfare: financial structure, shock persistence, and labor supply elasticity. When agents can self-insure only with money, inflation reduces wealth inequality but may raise consumption inequality. Otherwise, inflation reduces consumption inequality but may raise wealth inequality. Given persistent shocks and an inelastic labor supply, inflation may raise average welfare.

The idea that inflation has a distributional impact is not new, as it dates back to the work of Richard Cantillon in the early 18th century and more recently to the limited participation literature (for example). The difference here is that inflation is fully anticipated, there is production with endogenous labor supply, and different financial structures are studied. And while long-run inflation reduces wealth inequality, it is welfare-reducing because it increases consumption inequality.

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