Working Paper: NBER ID: w18225
Authors: Quamrul Ashraf; Boris Gershman; Peter Howitt
Abstract: We use an agent-based computational approach to show how inflation can worsen macroeconomic performance by disrupting the mechanism of exchange in a decentralized market economy. We find that increasing the trend rate of inflation above 3 percent has a substantial deleterious effect, but lowering it below 3 percent has no significant macroeconomic consequences. Our finding remains qualitatively robust to changes in parameter values and to modifications to our model that partly address the Lucas critique. Finally, we contribute a novel explanation for why cross-country regressions may fail to detect a significant negative effect of trend inflation on output even when such an effect exists in reality.
Keywords: inflation; macroeconomic performance; agent-based modeling; computational economics
JEL Codes: C63; E00; E31; E50
Edges that are evidenced by causal inference methods are in orange, and the rest are in light blue.
| Cause | Effect |
|---|---|
| Trend inflation > 3% (E31) | Average GDP (E20) |
| Trend inflation > 3% (E31) | Unemployment (J64) |
| Trend inflation > 3% (E31) | Inflation volatility (E31) |
| Trend inflation > 3% (E31) | Price dispersion (L11) |
| Increased price dispersion (D49) | Greater volatility in demand (E41) |
| Greater volatility in demand (E41) | More business failures (M13) |
| Higher inflation (E31) | More businesses fail (M13) |
| Endogeneity issue from Phillips-type relationship (C22) | Obscured negative long-run effect of inflation on output (E31) |