NATIONAL BUREAU OF ECONOMIC RESEARCH
NATIONAL BUREAU OF ECONOMIC RESEARCH

Credit Markets and the Welfare Costs of Inflation

Jose De Gregorio, Federico Sturzenegger

NBER Working Paper No. 4873
Issued in October 1994
NBER Program(s):   IFM

We construct a simple model in which high inflation imposes welfare costs because it affects the ability of the financial sector to screen between high and low cost producers. Consumers search for a low price and inflation reduces the incentives to search, resulting in an increase in the demand of high cost producers. We show that beyond a certain level of inflation there is a switch from a separating equilibrium to a pooling equilibrium, where financial institutions become unable to distinguish among clients. In this pooling equilibrium a larger share of credit is allocated to less efficient firms.

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Document Object Identifier (DOI): 10.3386/w4873

Published: Published as "Welfare Costs of Inflation, Seigniorage, and Financial Innovation", IMF, Vol. 38, no. 4 (1991): 675-704.

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