On The Welfare Cost Of Inflation In China

The inflation was always concerned by the public and troubled different governments for the long time. It was considered by the economic theory that mild inflation policy helps to stimulate the economy while the hyperinflation did harm. for the economy for it made the economy disorder. And this always made the policy makers feel confuses. In order to provide appropriate rationales and policy suggestions on how to deal with inflation to policy makers, the economists do lots of research on inflation. To achieve this goal, one must first figure out how much was the inflation’s influences on the economy, which was 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 had been one of the important part of macroeconomics especially monetary economics in recent decades.In order to measure the welfare cost of inflation, we must know the mechanism of the inflation made the welfare cost. Most scholar believed that when faced the inflation the individuals have to lower the money to hold which caused the economic efficiency and it made the individuals feel lost. When we know the mechanism of the welfare cost of inflation, the new problem was coming. Why the individuals need money. We need money because money has some function such as stored value and medium of exchange. So money was utility to its holders. When faced inflation we changed the amount of money we hold and this will make Loss of efficiency and such the welfare cost of inflation appears.In order to calculate the welfare cost of inflation, we must know the best level of inflation. Friedman believed when the nominal rate equals to zero, the inflation level was the best. For the nominal rate equals the real rate of the economy added the inflation rate, and the real rate was great than zero, so the best inflation level was lower than zero.When the best inflation level was given, to calculate the welfare cost of inflation became capable.(Bailey,1956) made the first empirical study on this problem. For the research of (Bailey,1956) has no micro foundation of the money and established his model in the partial equilibrium, the followers try their best to establish the micro foundation of monetary needed in general equilibrium. Following this way, lots of model were proposed. Such as OLG model of (Samuelson,1958), which was focus on the value stored function of the money; MIU model (Sidrauski,1967), which believe that holding money itself can bring the utility to the money holders; CIA model (Clower,1967), which supposed the consumer must use money to buy the commodity their needed; ST model(McCallum and Goodfriend,1987), which thought it takes time to buy community, and time was valuable to the family. Because the money can save the time of buying community so it can bring the utility to the family; MSM(Lagos and Wright,2005), which supposed the household must use the community of their produced to exchange the community of their need, when the coincidence-wants cannot be suited, the money’s function appears.In this paper, we firstly give a systematic review of the study in the field of the inflation cost, and then give the main theories of this field a detail review and at last we give a comment to this theories.Taking into account the actual situation in China, we choose the Bailey’s method and MIU model as the main model to measure the welfare cost of inflation for our country.For the data’s selection, we choose the data of1996Q1-2011Q3. Using Bailey’s method, the results show that when faced10%of inflation, the welfare cost was5.76%of GDP in the semi-log money demand function while4.94%in the log-log money demand function. Using MIU method, the results show that when faced10%of inflation, the welfare cost was5.67%of GDP in the log-log money demand function.Consider the existence of liquidity constraints in the economy, the result must be smaller than when we including the liquidity constraints in our model. This paper proposes to use the interest rate elasticity of money demand to measure the liquidity constraints in the economy for the first time. With the coefficient of money demand elasticity we estimated, we compared the liquidity constraints of America and China, and we found that china faced more liquidity constraints than America.The main innovation is as follows:1.This paper give a systematically describes to the development of the welfare cost of inflation. And the latest MS model was also introduced. In this paper, we also give the model which take the reality of the existence of liquidity constraints and family heterogeneity into account a detail introduce.2.In this paper we choose the data after1996, it make us avoid the interference of the extreme values.3.This paper proposes to use the interest rate elasticity of money demand to measure the liquidity constraints in the economy for the first time. This offer a new instrument for the further study of the welfare cost of inflation.