Research Of The Welfare Cost Of Inflation In China

Does inflation have the welfare cost? What kind of cost can be called the welfare cost of inflation? How to do the research of the welfare cost of inflation from its logic start point and research view point? In economics, How to decide its theoretic calculation, econometric calculation, and the welfare cost of inflation of China, based on its nation's past economic activities? To answer these questions is the whole content of this paper.The welfare cost of inflation means the economic efficiency loss caused by the actions of economy individuals having to change its holding monetary during the inflation. As Inflation is a basic monetary phenomenon, in order to solve the problem of the welfare cost of inflation, some related questions have to be answered. First, why people like to hold money on hand? Then, it focus on why money, especially the fiat money issued by the government, with no marginal cost of creating money and has no value itself has value? Last, how does the value of money form? To bridge these questions, we need to comb and analyze money demand, especially the evolvement money function idea.By combing money through macro-monetary theory—a traditional money demand and micro-monetary theory—a money demand theory based on micro foundation, a clue can be determined to do the research on the welfare cost of inflation. Through this clue, the theory framework and metric calculation can be built up, from the partial equilibrium assessment on the welfare cost of inflation by traditional money demand theory, to the general equilibrium assessment and calculation method of the welfare cost of inflation, based on micro-based contemporary monetary theory. This is the main logic of this research on the welfare cost of inflation. And based on the nation's realistic constraints, a research of the welfare costs of inflation in China can be outspread.When doing the practical research, the paper uses quarterly data, analyzing the period from the first quarter of 1992 to the forth quarter of 2006, totally 60 sample data. Based on the estimate of this paper, under a general standard model, the welfare costs of inflation in China is 5.5% of its GDP. Under the two main realistic constraints, also two conclusions are drawn, 1. Considering the factor of interest bearing deposits, the welfare costs of inflation is 18.7% of its GDP; 2. There is nearly no difference on the welfare costs of inflation considering intra-household model or not. Logically, the paper also did the investigation on the opposite of the welfare costs of inflation—the cost of disinflation, the conclusion is that the sacrifice ratio of output is 0.31%, with disinflation rate on each percent. According to the logic clue, this paper has ten chapters.Chapter one is the preface, which introduces the research background, logic clue, purpose, method, innovation and drawbacks.Chapter two is a narration of current research on the welfare cost of inflation.It gives the measurable definition of the welfare cost of inflation, according to the definition of the welfare cost of inflation, and the money demand theory based on both traditional monetary theory and micro-based contemporary monetary theory. Focus on the theoretical measurable definition, according to traditional monetary theory, it describes the econometric researches of the partial equilibrium assessment on the welfare cost of inflation, such as, Bailey(1956),Marty(1967),Barro(1972),Mussa(1977),Tower(1971)and etc. With the focus of monetary theoretical research changing from macro to micro, the estimation of the welfare cost of inflation moved on to the general equilibrium assessment based on micro based contemporary monetary theory. According to some different micro-based monetary models, it describes the econometric researches of the scholars, such as, Leach(1983),Cooley & Hansen(1989),Dotsey & Ireland(1994),Eckstein & Leiderman(1992),Luca(s1994,2000),Chadha & Haldane & Janssen(1998),Wolman(1997),Bakhshi & Martin & Yates(2002),Lagos & Wright(2005),Craig & Rocheteau(2006), and etc. At last, it gives the conclusion on the researches of native scholars on the welfare cost of inflation.Chapter three combs and analyzes the money demand theory of traditional money and the money of micro–based contemporary monetary theory. The traditional money demand theory studies people's demand on money and the value of money, according to the three functions of monetary—media of exchange, store value, and unit of account. From the point of view of Classical Quantity Theory of Money, money is treated just as a medium of exchange, and it is just as a layer of veil of real economy. Whereas in the view of Keynes and Keynesian, money has medium function (has relation with exchange), and it is an asset itself. So it has store value (reflecting in the purpose of speculating). In New Quantity Theory of Money, Friedman still treats money as"the temporary residence of purchase power"with function of store value of asset. The traditional money demand theory believes the emerging of money facilitates exchange, and it is the evolvement outcome of people's using and the need for money. The value of money can be explained well from reducing transaction costs by using indirect-matching-of-wants in lieu of double-coincidence-of-wants. But, fiat money issued by the government with zero marginal creating cost and no values itself, theoretically, its price is zero, but how can it have positive value? As an asset, how does the value of money exist? This triggers the famous Hahn's problem. To solve this problem, it is necessary to do a further research on questions such as what is money, its characteristics, positive values, etc, to search for a proper explanation, a new point of view of money theory with micro-foundation is needed.In economics studies, facing Hahn's problem, there is a long research on inducing general equilibrium models to illustrate the function of money. Among these studies, there are four models have wide recognition: Overlapping Generation Model (OG), Money-In-The-Utility Function Model (MIU), Cash-In-Advance Model (CIA),and Transaction Costs Model (TC). OG starts from the function of the store value of money, and demonstrated micro-foundation of money existence, as it defines money function as store value, not reveal any characteristics as a medium of exchange, so, the existence of money in OG is not a necessity. The following models MIU and CIA bring money into general equilibrium models through assumptions, and obtain positive money demand, although they have high practicality, their subjectivity are the drawbacks in the real business world. The money effective of Search Model is got from the practical exchange abstractly, it is very practical. But with the complex of real business world, currently, this method lacks the value of practical application. Although Shopping-Time Model is bit subjectivity on assuring shopping time, compare to the former, it has a very good micro knowledge base, and it is very practical, so when analysis the inflation welfare cost of China, Shopping-Time Model will be used mainly to expanding the analysis and estimations.Monetary theory with micro-foundation encircles the questions, such as, why people like to hold money on hand. Why does money have positive value? Puts money into the general equilibrium model, starts from the optimal household utility to calculate the whole utility amount, and uses a micro brand new point of view to give answers more logically.In this way, by the combed money demand theory, this paper uses traditional money demand theory and micro-foundation based contemporary money theory, and their definitions of money to solve the problems of the welfare cost of inflation.Chapter four sets up the theoretical framework and computation model from both traditional macro monetary theory and micro-based contemporary monetary theory.In the traditional macro monetary theory, Bailey application of the consumer'surplus idea to the demand of money believed that inflation is just as the excising tax on money, according to this, the welfare loss from tax on money is the area bounded on the bottom by the social cost of producing money ,which is zero, and bounded on the top by the demand curve, the only difference is the social cost of creating money is zero, so, in the traditional macro monetary theory, the welfare cost of inflation is the area under the money demand function.Lacking of micro-foundation, macro monetary economics has a large constraint, so, the application of consumer surplus idea which analyzing the welfare cost of inflation is just a rough utility amount. The idea lacks internal logical relationship when measuring household utility and whole utility amount of welfare costs. Whereas monetary theory with micro-foundation, especially MIU, which assumes money can bring utility, intuitively create a tight relation between a high inflation rate leading to a low quantity of money holdings and loss of household welfare, it is thoroughly accorded with optimal option assumption of rationalizing household of economic theory. Therefore, monetary model with micro-foundation, Lucas(1994,2000)posed Compensating Variation, household in order to live in a lower (higher) continuous inflation environment, people are willing to lose how much income loss (or obtain how much income compensation), this kind of income change is the measurement of the welfare cost of inflation.From the above, we can tell, either traditional macro monetary theory, or micro-based contemporary monetary theory, their definitions of the welfare cost of inflation can be described as the real cost of compensating a consumer for losing utility.Because the degree of inflation often is described by inflation rate, is there an optimal inflation rate which can make economy body realize maximum welfare when in its equilibrium? Bailey(1956)and Friedman(1969)posed, when marginal cost of social creating money is equal to the marginal cost of individual money holdings, social resources reach the Pareto Optimality and social welfares reach the maximum. In other words, the marginal cost of individual money holdings is zero, which means the generalized interest rate is zero. This is the famous Friedman Rule. So, in fact, optimal welfare inflation is a deflation rate, which approximately equal to the real asset rate.Chapter five solves the questions of the selection of data period, selection of data types, selection of varieties, and data process, etc, when discuss the welfare cost of inflation in China. And it provides the data for the following chapters when doing econometric research.According to the theoretical model of the welfare cost of inflation, the partial equilibrium estimate model of China under traditional monetary demand theory stated by this article, and the MIU, Shopping-Time Model, and generalize Shopping-Time Model with the consideration of the constraints of China's practical situation, the general equilibrium of the welfare cost of inflation in China is applied, and according to the characters of the economy data of China, the paper uses quarterly data, analyzing the period from the first quarter of 1992 to the forth quarter of 2006, totally 60 sample data, variety nominal rate r, monetary nominal balance M1 and M2, nominal GDP, considering the real GDP of the year 1985 as unchanged price, quarter rate CPI, considering the year of 1985 as the basic quarter CPI of 100, etc. the quarterly change of variety is adjusted by the updated X-12.Based on established theory framework of the welfare cost of inflation, Chapter six uses traditional money demand theory to determine the framework and econometric model of the welfare cost of inflation. According to the economy data of China decided in Chapter Five, also use Baily's consumer surplus idea, this chapter discusses the welfare cost of inflation under Lucas's monetary demand chart, then, with the help of Lucas's chart, this chapter focuses on analysis of long term cointegration relationship between money demand and interest rate in China, then it obtains the welfare costs of inflation in China, which is about 5.4% of GDP.Chapter seven investigates the welfare cost of inflation in China under general equilibrium, according to the micro based contemporary monetary theory. It mainly uses these two micro monetary model—MIU and Shopping-Time Model, with the help of Compensating Variation Theory, comes to the conclusion, that the general equilibrium of the welfare cost of inflation in China is 6.2% of GDP by using MIU, which is a little bit higher than the partial equilibrium estimation; while the general equilibrium of the welfare cost of inflation in China is 5% by using Shopping-Time Model, which is a little bit lower than the partial equilibrium estimate and the general equilibrium estimate by using MIU.After describing statistical analysis of the reality constraints of China, focuses on the two main reality constraints of the too large interest bearing deposits and intra-household of urban and rural area, it properly develops the Shopping-Time Model, makes it become the generalize Shopping-Time Model with a wider definition of multi-money type and multi-economy-individual. And it also does the further discussion of the theoretical analysis framework and quantity model under the general equilibrium estimate of welfare cost of inflation in China, and comes to these two conclusions:①The welfare cost of inflation in China is about 18.7% of GDP after considering the interest bearing deposits;②When considering intra-household of urban and rural area, there is no difference between the welfare cost of inflation in China without considering it.According to the logical line, from the recent historical data of China, Chapter nine does the research on the other side of the welfare cost of inflation—the cost of disinflation, that is the question of output loss rate of China, it comes to the conclusion, the sacrifice ratio of output would be 0.31% of GDP, with disinflation rate on each percent. Chapter ten is the conclusion and expectation. It draws the conclusion on the welfare cost of inflation in China and the cost of disinflation, and it also makes the comparison of the research results of other countries, so as to give a complete recognition on inflation welfare cost of China. It starts from the economic efficiency loss, or we can say, and it makes the theoretical analysis and quantity research on inflation, from the welfare cost point of view, which is very rare among the researches in China. By comparing with other countries, the welfare cost of inflation in China is not too high, it lies on the middle-lower level, and by moderately tight economic policy, the inflation can be decreased, and the welfare gain of inflation would bigger than output loss, and the gain from disinflation is far bigger than the loss from it. It gives a standard level of welfare cost of inflation when whether the economy is good or bad, and whether inflation is good or disinflation practically. Finally, it gives the expectation on the three research directions of the welfare cost of inflation.The main innovation is as followed:1. In domestic, according to documents we collected, most of the studies on the inflation being discussed from the point of view of the redistribution of fortune, it is very rare to do from the economic efficiency loss that is from the welfare cost point of view, and it is especially rear to see the quantity research on it. Plus, the present econometric research starts from single model, they are not complete and not systematic, and they can't provide a research line. This article tries to provide such kind of research point of view: according to the reorganization of money demand theory of both macro and micro, along with the evolution of the function of money, it sets up the logic line of researching on the welfare cost of inflation. With the help of this logic line, the research on theoretical framework and quantity method of inflation welfare cost is carried out. Under this kind of research point of view, this paper sets up the partial equilibrium estimate model of the welfare cost of inflation under traditional money demand theory, the general equilibrium estimate model of the welfare cost of inflation under micro based contemporary monetary theory, and the general equilibrium estimate model of the welfare cost of inflation under constraints, this paper does a complete and systematic research on the welfare cost of inflation in China.2. It finds out two real constraints and their characteristics in doing research of the welfare cost of inflation in China—too large interest bearing deposits and intra-household of urban and rural area, it comes to the conclusion of the constraints character of the welfare cost of inflation in China: The welfare cost of inflation in China is about 18.7% of GDP after considering the interest bearing deposits; when considering intra-household of urban and rural area, there is no difference between the welfare cost of inflation in China without considering it. The research on constraints situation of China's inflation welfare cost is very rare to find in present research papers.3. According to real constraints of China, managing the analysis of mainstream standards, it establishes the theory framework which suits for the welfare cost of inflation in China and makes a demonstration based on economy data of China, and it comes to these two conclusions: By comparing with other countries, the welfare cost of inflation in China is not too high, it lies on the middle-lower level, and by moderately tight economic policy, the inflation can be decreased, and the welfare gain of inflation would bigger than output loss, and the gain from disinflation is far bigger than the loss from it. It gives a standard level of welfare cost of inflation when whether the economy is good or bad, and whether inflation is good or disinflation practically.