Price Dispersion and the Costs of Inflation

Abstract

AbstractThe new Keynesian literature typically makes the assumption that firms always have to satisfy demand, which is at odds with profit‐maximizing behavior under Calvo pricing when long‐run inflation is positive. Our model, which relaxes this assumption, predicts that inflation causes a substantially smaller loss in effective aggregate productivity compared to a benchmark model without the possibility of rationing. Moreover, under positive inflation, firms choose smaller markups over marginal costs in our model than in the benchmark model. As a result, our analysis suggests that the standard new Keynesian model may exaggerate the welfare costs of inflation.