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 Economics
Link to this Page: cepr.org/active/publications/discussion_papers/dp.php?dpno=5939

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.