Inflation and the Informativeness of Prices

   (1487 K)

This paper studies the welfare effects of the relative price variability arising from inflation. When agents interact in anonymous markets, with customers buying from new suppliers each period, relative price variability benefits customers and cannot harm suppliers substantially. But if customers and suppliers form long-term relationships, prices have an informational role: a potential customer uses current prices as signals of future prices. Inflation reduces the informativeness of current prices, causing customers to make costly mistakes about which relationships to enter. In addition, the reduced informativeness of prices makes demand less price-elastic, thereby increasing markups. Both effects can be quantitatively significant at moderate inflation rates.

Published:

• Ball, Lawrence and N. Gregory Mankiw, "Interpreting the Correlation Between Inflation and the Skewness of Relative Prices: A Comment on Bryan and Cecchetti," Review of Economics and Statistics, Vol. 81, no. 2 (May 1999): 197-198. ,
• Journal of Money, Credit and Banking, vol. 35, no. 2, (April 2003), pp. 177-196

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