In macroeconomics, the welfare cost of inflation comprises the changes in

social welfare Welfare, or commonly social welfare, is a type of government support intended to ensure that members of a society can meet basic human needs such as food and shelter. Social security may either be synonymous with welfare, or refer specifical ...

caused by

inflation In economics, inflation is an increase in the general price level of goods and services in an economy. When the general price level rises, each unit of currency buys fewer goods and services; consequently, inflation corresponds to a reduct ...

. The traditional approach, developed by Bailey (1956) and Friedman (1969), treats real money balances as a consumption good and inflation as a

tax A tax is a compulsory financial charge or some other type of levy imposed on a taxpayer (an individual or legal entity) by a governmental organization in order to fund government spending and various public expenditures (regional, local, or n ...

on real balances. This approach measures the welfare cost by computing the appropriate area under the

money demand In monetary economics, the demand for money is the desired holding of financial assets in the form of money: that is, cash or bank deposits rather than investments. It can refer to the demand for money narrowly defined as M1 (directly spendable ...

curve.

Fischer Fischer is a German occupational surname, meaning fisherman. The name Fischer is the fourth most common German surname. The English version is Fisher. People with the surname A * Abraham Fischer (1850–1913) South African public official * A ...

(1981) and Lucas (1981), find the cost of inflation to be low. Fischer computes the

deadweight loss In economics, deadweight loss is the difference in production and consumption of any given product or service including government tax. The presence of deadweight loss is most commonly identified when the quantity produced ''relative'' to the amoun ...

generated by an increase in inflation from zero to 10 percent as just 0.3 percent of GDP using the monetary base as the definition of money. Lucas places the cost of a 10 percent inflation at 0.45 percent of GDP using M1 as the measure of money. Lucas (2000) revised his estimate upward, to slightly less than 1 percent of GDP. Ireland (2009) extends this line of analysis to study the recent behavior of U.S. money demand. Structural models are a recent alternative to econometric estimates of the triangle under an estimated money demand curve. Cooley and Hansen (1989)

calibrate In measurement technology and metrology, calibration is the comparison of measurement values delivered by a device under test with those of a calibration standard of known accuracy. Such a standard could be another measurement device of known ...

a cash-in-advance version of a business cycle model. They find that the welfare cost of 10 percent inflation is about 0.4 percent of GNP. Craig and Rocheteau (2008) argue that a search-theoretic framework is necessary for appropriately measuring the welfare cost of inflation. Lagos and

Wright Wright is an occupational surname originating in England. The term 'Wright' comes from the circa 700 AD Old English word 'wryhta' or 'wyrhta', meaning worker or shaper of wood. Later it became any occupational worker (for example, a shipwright i ...

(2005) model monetary exchange and provide estimates for the annual cost of 10 percent inflation to be between 3 and 4 percent of GDP.

References

{{Reflist Inflation Business cycle Welfare economics