Research, Of Welfare Cost Of Inflation

In 2008,the inflation caused by the spiral prices of food and petroleum became the most significant economic issue all over the world.The appeal of curbing the inflation is all around.However,is the welfare cost of inflation much? To China,which is also suffered with the inflation,how much is its welfare cost of inflation? This paper will give all the answers to these questions.The research on the welfare cost of inflation starts with Bailey(1956),he defined the welfare cost of inflation as the area under the inverse demand function---the consumers' surplus—that could be gained by reducing the interest rate from r to zero. Lucas(2000) took advantage of Bailey's definition to calculate the cost of welfare inflation of U.S.based on time series for 1900-94.For the log-log money demand function,m_r = Ar^-0.5,at a six percent interest rate,for example,the welfare cost is one point two percent of national income.Meanwhile,when nominal interest decreases from twelve percent to two percent,then the welfare cost will reduce by one percent of GDP.By the development of monetary theory,researchers find out that apart from the value storage function,money also have other functions,such as trading.Considering its trading function,most literature take two patterns to integrity money into the model. One pattern is that assuming holding money can bring consumers' utility,and then include money into the utility function(MIU);and another pattern is that assuming consumer must use money to buy nonstorable goods,and then it shapes the Cash-in-advance constrain,CIA,or introduce the trading techniques into the model, assuming the use of money can bring savings of trading time,then it becomes shopping-time model.MIU model considers money holding can bring convenient,save trading cost,then have much more time to engage in production,so money holding actually increases the utility of individual.When inflation happens,it will cause the decrease of actual money balance,the loss of consumers' welfare,and then it becomes the welfare cost. Dotsey and Ireland(1996) found in a general equilibrium money model,four percent annual inflation rate cause 0.41%consumers' income loss.In a CIA model,money can not be put into the utility function directly.So researchers assume that part of or all of the purchase of goods must use cash,and this restriction is called Clower constrain.Cooley and Hansen(1989,1991) figured out the welfare cost of inflation in USA,finding out 10%cost of inflation welfare is 0.38%of output. After Bailey(1956)'s inaugurating research,economists construct models like MIU, CIA,and shopping-time model based on different assumptions;also elicit different welfare costs of inflation.However,the same idea lies in these models,that is,by putting the actual holding money into the utility function or restrictions and optimizing the calculation of models,we can get the relationship between the inflation rate and the consumers' utility.Comparing the levels of utility under different balance conditions,we can get the welfare cost of inflation:when nominal interest rate is zero, and the consumers' utility reach its max,considering under some inflation level,what ratio of income or consume compensation is needed to leave consumers indifferent between r and 0.As a result,the part of income or consume compensation is the welfare cost of inflation.As last,this paper uses the Mccallum-Goodfriend framework to calculate the welfare cost of inflation,based on China time series for 1992-2008.The study shows:there exist positive correlation between the welfare cost of inflation and nominal interest rate;between those years,the welfare cost of inflation is between 0.5699%of GDP and 1.8732%of GDP,not as high as what we thought before;still in the year 2008, the actual welfare cost of inflation is 0.8031%of GDP,about RMB 237.65255 billion; The individual loss of welfare is RMB 182.8096527 based on the population of 1.3 billion;even if in 1994,when the inflation is most serious reaching 24.1%,the cost of inflation welfare is only 1.8199%of GDP;and we also find another significant thing that in 1998 and 1999 when our country appeared deflation,the inflation rate of those two years is -0.8%and -1.4%respectively,after the financial crisis in Asia,those two years' welfare cost of inflation took up of 1.0941%and 0.7335%of GDP respectively, and this also states that the deflation is harmful.Moreover,this states that only when the nominal interest rate is zero,the social welfare is optimal.To validate the results further,we use Bailey(1956)'s method recalculation the welfare cost of inflation of our country.We find:the cost of our country is between 0.5635%and 1.8055%of GDP,the same small;the results calculated by the Bailey (1956)'s method are smaller than our results,but the difference is very little,and the difference is large gradually while the increase of nominal interest rate.