DP5939 Inflation as a Redistribution Shock: Effects on Aggregates and Welfare

Author(s): Matthias Doepke , Martin Schneider

Publication Date: November 2006

Keyword(s): aggregate effects , inflation , redistribution , welfare

JEL(s): D31 , D58 , E31 , E50

Programme Areas: International Macroeconomics , Public Policy

Link to this Page: www.cepr.org/pubs/dps/DP5939.asp.asp

Episodes of unanticipated inflation reduce the real value of nominal claims and thus redistribute wealth from lenders to borrowers. In this study, we consider redistribution as a channel for aggregate and welfare effects of inflation. We model an inflation episode as an unanticipated shock to the wealth distribution in a quantitative overlapping-generations model of the U.S. economy. While the redistribution shock is zero sum, households react asymmetrically, mostly because borrowers are younger on average than lenders. As a result, inflation generates a decrease in labour supply as well as an increase in savings. Even though inflation-induced redistribution has a persistent negative effect on output, it improves the weighted welfare of domestic households.