## Welfare Cost of (Low) Inflation: A General Equilibrium Perspective

_IMF Working Papers, August 1, 1998_

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## Bibliographic details
- Authors: Howell H Zee
- Published: August 1, 1998
- Series: IMF Working Papers
- DOI: https://doi.org/10.5089/9781451853445.001

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### Summary and Main Finding
- Provides general equilibrium estimates of the steady-state welfare gains of lowering inflation from a low level to close to price stability.
- Uses an overlapping-generations growth model.
- Money demand is modeled on the basis that real money balances are a factor of production.
- Main quantitative conclusion: the welfare cost of low (positive) inflation is quantitatively very modest — under 0.2 percent of GDP annually within reasonable ranges of all parameter values.
- Qualitative result: inflation unambiguously reduces capital intensity, drives up the before-tax real rate of return to capital, and unambiguously imposes a life-time welfare cost.

### Model and Key Assumptions
- Framework: overlapping-generations growth model.
- Money demand specification: real money balances enter as a factor of production.
- Asset return relation: assumes a standard Fisher equation modified by the presence of an income tax.
- Taxation: presence of an income tax affects the Fisher equation and hence real returns.

### Quantitative Results and Interpretation
- Welfare cost estimate: under 0.2 percent of GDP annually (within reasonable parameter ranges).
- Effects on capital and returns:
  - Inflation reduces capital intensity (unambiguous).
  - Inflation increases the before-tax real rate of return to capital (unambiguous).
- Welfare implication: inflation imposes a life-time welfare cost (unambiguous), but the magnitude is modest as quantified above.

### Policy Implications
- Lowering inflation from a low level toward price stability yields steady-state welfare gains, but the quantified gains are small (under 0.2 percent of GDP annually).
- Given the model’s structure and parameter sensitivity, policy trade-offs involving the costs and benefits of reducing already-low inflation should account for the modest quantitative welfare gains highlighted.

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_Source: https://www.imf.org/en/publications/wp/issues/2016/12/30/welfare-cost-of-low-inflation-a-general-equilibrium-perspective-2682_