WELFARE COST OF INFALTION IN A NEW KEYNESIAN MODEL

Abstract

AbstractWe study the welfare cost of inflation in a new Keynesian dynamic stochastic general equilibrium model. Nominal prices and wages are subjected to Taylor‐style adjustments in the benchmark model. We find that the welfare cost of inflation in a new Keynesian dynamic stochastic general equilibrium model is much higher than its counterpart in a real business cycle model. We also find that the welfare cost of inflation increases linearly with the inflation rate with the introduction of monopolistic competition but rises faster as the inflation rate increases with the introduction of nominal rigidity. Alternative price and wage setting schemes, such as Rotemberg and Calvo‐style adjustments would yield welfare costs of moderate inflation that are 2–10 times higher.