Working Paper: CEPR ID: DP2111
Authors: Hanswerner Sinn; Robert Lucas
Abstract: The paper argues that Lucas overestimates the Friedman-Bailey type of welfare cost of inflation and neglects other important welfare effects. With an alternative interpretation of the non-observability of low interest rates than the one Lucas gave and the introduction of taxes that reduce the opportunity cost of money holding, the welfare cost shrinks to one third of Lucas' estimate. The neglected welfare effects of inflation include an adverse Baumol-Tobin effect on growth and international capital movements, historical cost accounting for tax purposes, uncertainty about the price level and the relationship between inflation, relative prices and structural change.
Keywords: inflation; cost of inflation
JEL Codes: E31; F41
Edges that are evidenced by causal inference methods are in orange, and the rest are in light blue.
| Cause | Effect |
|---|---|
| nominal interest rates (E43) | opportunity cost of money holding (E41) |
| transaction costs (D23) | welfare cost of inflation (D69) |
| inflation (E31) | economic growth (O49) |
| inflation (E31) | real interest rates (E43) |
| real interest rates (E43) | capital outflows (F32) |
| capital outflows (F32) | economic growth (O49) |
| nominal contracts (K12) | real distortions (H31) |
| real distortions (H31) | welfare-reducing outcomes (I38) |
| historical cost accounting (M41) | economic distortions (H31) |