On the general equilibrium costs of perfectly anticipated inflation

Abstract

In monetary models where M0 has no social costs and a positive demand for cash and deposits is taken as a primitive, we show that the compensating variation in endowment is the exact general equilibrium measure of welfare costs of perfectly anticipated inflation. As a consequence, we show that a good approximation to the welfare costs of inflation is given by the area under the compensated demand for M0, a result that brings us back to Bailey (J Polit Econ 64:93-110, 1956). The estimated welfare costs of inflation are bounded at less than a quarter of a percent of the GDP for the U.S. economy.