The Welfare Cost Of Inflation: Theory And Empirical

For a long time, the inflation problem is always concerned by the public and disturbing different governments. On one hand, mild inflation policy helps to stimulate the economy. On the other hand, higher inflation will lead to lower living standard and brings people welfare costs. It is quite difficult to trade off between these two aspects, which confuses policy makers a lot. The ambition that economists do research on inflation lies in providing appropriate rationales and policy suggestions on how to deal with inflation. To achieve this goal, one must first figure out the inflation's influences on the economy, which is related to the problem of how to measure and estimate the welfare cost of inflation. Thus, the problem of measuring the welfare cost of inflation has been an important part of macroeconomics in recent thirty years.In China, since the reform and opening-up, the country has experienced high inflation through the late 1980s and early 1990s, as well as the deflation in the subsequent ten years. The inflation rate has begun to surge up since 2006. Which attitude should we adopt toward inflation? Should we pierce the inflation bubbles or just let it be and walk in the middle of the road? Mere qualitative investigations appear to be unpersuasive and we need to do quantitative analyses in order to make compatible policies. Based upon the results of western scholars, this thesis carries out empirical analyses with Chinese macroeconomic data. Also, the thesis give some considerable suggestions on the decision making of monetary policy.This thesis has been divided into four chapters. In Chapter One, we introduce the originals of the problem of inflation welfare costs, discuss the theoretical and practical meaning of this problem, and make the writing purpose and methodology clear. Also, we mention our innovations and shortages of this thesis. In Chapter Two, we summarize the historical literatures and make comments on them, from traditional Bailey-Lucas methods and the newest searching methods, which lays a solid theoretical foundation for the empirical analyses of inflation welfare costs in Chapter Three. In Chapter Three, we carry out empirical analyses on the estimation of the Chinese inflation welfare costs. First, based on the theoretical foundation of Meltzer's money demand function (1963), using the seasonal data (from 1998 to 2008) of Chinese real broad money balances, real commodity balances for transactions and interbank offered rates in seven days, we estimate Chinese long-run real money balance demand function with the methods of Johanson Cointegration Test and Vector Error Correction Model. Then separately we estimate the welfare costs of inflation with the Bailey's welfare triangle method (1956) and Sidrauski (1967), McCallum, Goodfriend (1987) compensation methods. In the last part of this chapter, we compare the computation results of these three methods. In Chapter Four, we summarize the whole thesis, make conclusions and give some suggestions according to the realities of the inflation in China.