Essays on Inflation and Output: A Search-Theoretic Approach

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Liu, Qian
Economics , Monetary Policy , Search Theory , inflation and output
This dissertation examines the welfare effects of inflation on employment and output in three different market settings. The theoretical frameworks build on recent studies in the monetary search literature that explicitly models the microfoundations of money and study how monetary policy interacts with real variables. The first essay studies the relationship between inflation and unemployment in a general equilibrium framework where inflation has differential effects on employed and unemployed workers. The model finds that inflation can either increase or decrease employment and output, depending on goods and labor market institutions. Sales taxes, the degree of competitiveness in the goods market and imperfect indexation of unemployment insurance benefits are the major factors determining the direction of this relationship. Through a comparison of these parameters, the model predicts an inflation-unemployment relation that is qualitatively consistent with the empirical evidences. The second essay, co-authored with Liang Wang and Randall Wright, investigates the effect of inflation on people's trading behavior in the goods market. By focusing on buyers' search intensity on the extensive margin, the model unambiguously predicts a rise in inflation leads to an increase in the speed with which agents spend their money and velocity. This is consistent with the phenomenon described by the conventional "hot potato" effect of inflation. We also discuss the welfare implications of different monetary policy. In some circumstances inflating above the Friedman rule may be optimal, but the effect of inflation on output is always negative. The third essay, co-authored with Allen Head, Guido Menzio and Randall Wright, examines the effect of monetary growth on output in a general equilibrium model where price stickiness arises as an equilibrium outcome. The model makes several predictions about individual firms' price adjustment behavior that are consistent with micro data. For instance, the frequency (duration) of price changes increases (decreases) with inflation and the price change hazard declines over time. In contrast to the New Keynesian literature, price rigidities in our model does not generate monetary non-neutrality. Higher inflation reduces real output in the long run, but changes in the aggregate price level has no effect on real allocations.
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