Agenda

Klaus Adam (UCL and Mannheim) - The Misallocation Costs of Inflation: A Sufficient Statistics Approach

Abstract:

We show that the misallocation costs of different steady-state inflation rates can be estimated from micro price data via a set of sufficient statistics. The approach works for a broad class of price-setting frictions, including time and state-dependent frictions and allows for heterogeneity in unobserved product fundamentals (productivity, mark-ups, quality). Applying the approach to the micro price data underlying the U.K. consumer price index, we find that misallocation is minimized at an inflation rate of approximately 2%. The costs of permanently higher or lower inflation are significant and highly symmetric: moving inflation to 10% (or -6%) leads to an aggregate productivity loss of about 1.0% per period. Misallocation costs are substantial even when inflation is optimal because (i) individual products have different distortion-minimizing inflation rates, and (ii) sticky prices distort relative prices even when inflation is optimal.  Component (i) generates an additional productivity loss of 0.4% per period, while component (ii) is only identified under more restrictive assumptions, but can be as high as 1.9% per period.