Working Paper: NBER ID: w4873
Authors: Jos De Gregorio; Federico Sturzenegger
Abstract: We construct a simple model in which high inflation imposes welfare costs because it affects the ability of the financial sector to screen between high and low cost producers. Consumers search for a low price and inflation reduces the incentives to search, resulting in an increase in the demand of high cost producers. We show that beyond a certain level of inflation there is a switch from a separating equilibrium to a pooling equilibrium, where financial institutions become unable to distinguish among clients. In this pooling equilibrium a larger share of credit is allocated to less efficient firms.
Keywords: Inflation; Credit Markets; Welfare Costs
JEL Codes: E31; E44
Edges that are evidenced by causal inference methods are in orange, and the rest are in light blue.
| Cause | Effect |
|---|---|
| high inflation (E31) | efficiency of credit allocation (D61) |
| efficiency of credit allocation (D61) | welfare (I38) |
| high inflation (E31) | search behavior (D83) |
| search behavior (D83) | demand for different types of firms (J23) |
| high inflation (E31) | pooling equilibrium (D51) |
| pooling equilibrium (D51) | efficiency of credit allocation (D61) |