Sunel, Enes (2010): On inflation, wealth inequality and welfare in emerging economies.
Download (485kB) | Preview
Evidence shows that globally observed disinflation in the last two decades has been more predominant in emerging economies. This paper undertakes a quantitative investigation of the distributional and welfare consequences of a sharp reduction in inflation in a monetary model of a small open economy with uninsured idiosyncratic earnings risk. Consumers hold non-interest bearing real balances (demand deposits) that economize transactions costs of consumption and internationally-traded risk-free bonds (term deposits) that are useful for consumption smoothing. Bonds are modeled as inflation-indexed to incorporate financial dollarization. Analytical results for deterministic economies show that alternative fiscal responses to inflationary finance create various redistributive wealth effects in addition to wealth-eroding and consumption-distorting effects of inflation. The stochastic model is calibrated to Turkish data and is used to compare stationary equilibria with quarterly inflation rates of 15% (for 1987:1-2003:4) and 2% (for 2004:1-2009:4) under alternative fiscal arrangements. I find that (i) when uniform transfers are endogenous, reducing inflation lowers aggregate welfare by 2.65% in terms of compensating consumption variation. This is because the reduction in the costs of inflation for the poor is less than the decrease in transfers. This also tightens natural debt limits, increases precautionary savings motive and causes the distribution of bonds to be more equitable. When endogenous transfers are proportional to individual-specific inflation tax payments, aggregate welfare increases by 0.5%. This is because proportional transfers do not drive redistributive effects. Welfare gains increase further (1.67%) if wasteful spending is endogenous. The model also generates a cross sectional portfolio consistent with the disaggregated deposits data and the literature.
|Item Type:||MPRA Paper|
|Original Title:||On inflation, wealth inequality and welfare in emerging economies|
|Keywords:||Small open economy; incomplete markets; welfare effects of inflation|
|Subjects:||D - Microeconomics > D3 - Distribution > D31 - Personal Income, Wealth, and Their Distributions
E - Macroeconomics and Monetary Economics > E5 - Monetary Policy, Central Banking, and the Supply of Money and Credit > E52 - Monetary Policy
F - International Economics > F4 - Macroeconomic Aspects of International Trade and Finance > F41 - Open Economy Macroeconomics
|Depositing User:||Enes Sunel|
|Date Deposited:||07. Nov 2010 18:17|
|Last Modified:||31. Dec 2015 01:59|
Aiyagari, S. Rao (1994): "Uninsured Idiosyncratic Risk and Aggregate Uncertainty," The Quarterly Journal of Economics, 109(3), 659-684.
Akyol, A. (2004): "Optimal Monetary Policy in an Economy with Incomplete Markets and Idiosyncratic Risk," Journal of Monetary Economics, vol. 51(6), 1245-1269.
Albanesi, S. (2007): "Inflation and Inequality," Journal of Monetary Economics, vol. 54(4), pages 1088-1114.
Avery, R. B., Elliehausen, G. E., and Kennickell, A. B. (1987): "Changes in the Use of Transactions Accounts by American Families," Federal Reserve Bulletin, 72 (2), 87-107.
Berument, H., and Gunay, A. (2003): "Exchange Rate Risk and Interest Rate: A Case Study for Turkey," Open Economies Review, vol. 14(1), 19-27.
Berument, H., and Guner, N. (1997): "Inflation, Inflation Risk and Interest Rates: A Case Study for Turkey," METU Studies in Development, 24 (3), 319-327.
Bircan, F., and Tansel, A. (2006): "Education and Wage Equality in Turkey, 1994-2002: A Quantile Regression Analysis," ESPE Conference.
Catao, L. A. V., and Terrones, M. (2005): "Fiscal Deficits and Inflation," Journal of Monetary Economics, vol. 52(3), 529-554.
Chatterjee, S., and Corbae, D. (1992): "Endogenous Market Participation and the General Equilibrium Value of Money," Journal of Political Economy, vol. 100(3), 615-646.
Chiu, J., and Molico, M. (2010): "Liquidity, Redistribution, and the Welfare Cost of Inflation," Journal of Monetary Economics, vol. 57(4), 428-438.
De Nicolo, G., Ize, A., and Honohan, P. (2003): "Dollarization of the Banking System: Good or Bad?" IMF Working Papers 03/146.
Doepke, M., and Schneider, M. (2006): "Inflation as a Redistribution Shock: Effects on Aggregates and Welfare," NBER Working Papers 12319.
Easterly, W., and Fischer, S. (2001): "Inflation and the Poor," Journal of Money, Credit and Banking, Blackwell Publishing, vol. 33(2), 160-78.
Erosa, A., and Ventura, G. (2002): "On Inflation As a Regressive Consumption Tax," Journal of Monetary Economics, Elsevier, vol. 49(4), 761-795.
Fischer, S., Sahay, R., and Vegh, C. A. (2002): "Modern Hyper- and High Inflations" Journal of Economic Literature, vol. 40(3), 837-880.
Honohan, P. (2007): Dollarization and Exchange Rate Fluctuations," The World Bank, Policy Research Working Paper Series, 4172.
Honohan, P., and Shi, A. (2001): "Deposit Dollarization and the Financial Sector in Emerging Economies," The World Bank Policy Research Working Paper Series, 2748.
Huggett, M. (1993): "The Risk-Free Rate in Heterogeneous-Agent Incomplete-Insurance Economies," Journal of Economic Dynamics and Control, 17(5-6), 953-969.
Iacoviello, M. (2005): "House Prices, Borrowing Constraints, and Monetary Policy in the Business Cycle," American Economic Review, vol. 95(3), 739-764.
Imrohoroglu, A. (1992): "The Welfare Cost of Inflation Under Imperfect Insurance," Journal of Economic Dynamics and Control, vol. 16(1), 79-91.
Imrohoroglu, A., and Edward C. P. (1991): "Evaluating the Welfare Effects of Alternative Monetary Arrangements," Quarterly Review, Federal Reserve Bank of Minneapolis, issue Sum, 3-10.
Ize, A., and Levy Yeyati, E. (2003): "Financial Dollarization," Journal of International Economics, vol. 59(2), 323-347.
Kehoe, T. J., Levine, D. K., and Woodford, M. (1990): "The Optimum Quantity of Money Revisited," Federal Reserve Bank of Minneapolis Working Papers, 404.
Kimbrough, K. P. (1986): "The Optimal Quantity of Money Rule in the Theory of Public Finance", Journal of Monetary Economics, 18, 277-284.
Levy Yeyati, E. (2006): "Financial Dollarization: Evaluating the Consequences," Economic Policy, vol. 21(45), 61-118.
Ljungqvist, L., and Sargent, T. J. (2004): "Recursive Macroeconomic Theory, 2nd Edition," MIT Press Books, ed. 2, vol. 1, number 026212274x.
Meh, C., Rios-Rull, J., and Terajima, Y. (2008): "Aggregate and Welfare Effects of Redistribution of Wealth Under Inflation and Price Level Targeting", Bank of Canada Working Papers, 08-31.
Mendoza, E. G., Quadrini, V., and Rios-Rull, J. (2007): "On the Welfare Implications of Financial Globalization Without Financial Development," NBER Working Papers, 13412.
Mendoza, E. G., and Uribe, M. (2000): "Devaluation Risk and the Business Cycle Implications of Exchange Rate Management," Carnegie-Rochester Conference Series on Public Policy, 53(1), 239-296.
Molico, M. (2006): "The Distribution Of Money And Prices In Search Equilibrium," International Economic Review, vol. 47(3), 701-722.
Mulligan, C., and Sala-i-Martin, X. (2000): "Extensive Margins and the Demand for Money at Low Interest Rates," Journal of Political Economy, 2000, 108(5), 961-991.
Ragot, X. (2008): "The Case for a Financial Approach to Money Demand," PSE Working Papers, 2008-56.
Reinhart, C. M., Rogoff, K., and Savastano, M. A. (2003): "Addicted to Dollars" NBER Working Papers 10015.
Tauchen, G. (1986): "Finite State Markov-Chain Approximation to Univariate and Vector Autoregressions," Economics Letters 20: 177-181.
Wen, Y. (2010): "Liquidity Demand and Welfare in a Heterogeneous-Agent Economy," Federal Reserve Bank of St. Louis Working Papers, 2010-009.