The Research Of China’s Inflation Welfare Cost

The research of inflation welfare cost is to calculate the efficiency loss that inflation brings to economy by some measurement methods. The ultimate goal of developing economy is to improve welfare of citizen, but the existence of inflation would hurt the economy, as a consequence, dead loss will bring our economy diverge from Pareto Optimality. Our economy has made great progress from reform and open policy, meanwhile, we need to focus on the phenomenon that along with development progress, inflation always exists and has been the major problem in some years. In conclusion, we need put much effort to administer inflation in the process of economic development. On the basis of understanding the specific effects caused by inflation, we can make targeted measures to cope with different types of inflation and provide theoretical basis for macroeconomic policy intended to manage inflation.The first question we faced is how to incorporate money into model, which means we need to explain the form of money in the model and its theoretical basis. In order to solve this question, scholars have made various attempts, and in this process they established a series of Monetarism models. For example, MIU model initially assume that money will bring about utility to consumers, while CIA model limits transactions by dividing it into two parts and one part must use money. Besides, shopping time model describes that transaction hardly conduct without money considering the two-way demand match, while the existence of money can tackle with this problem, make it easier for transaction and thus money become widely accepted by transaction participants.These models can simulate the economic operation process after incorporating money into model, which also provides convenience for calculating inflation welfare cost. Milton Friedman defined the optimal inflation rate that indicates zero dead loss and Pareto Optimality. This paper is based on MIU model. The idea to calculate inflation welfare cost comes from Lucas (2000):Our work is to figure out the amount of consumption at the nominal interest rate that can compensate consumer and reach the same utility relative to the consumption and money demand at the steady state. The original MIU model assumes monetary balance does not have any income, which would overstate inflation welfare cost. However, in the reality, monetary balance holding by the public can bring benefits and the minimum-benefits are demand deposit interest. Thus, we improved MIU model by adding the concept of interest-bearing money. In the new model, inflation welfare cost is determined by the interest rate spread rather than the nominal interest rate.The second question is about welfare cost of inflation volatility. Since it is difficult to directly calculate welfare cost of inflation volatility, we choose welfare cost of economic volatility as an intermediate to indirectly calculate welfare cost of inflation volatility. Similarly to the foreign literature, we expect that inflation volatility will bring about welfare benefit and welfare cost, but their absolute amount and relative amount are small.The results of our research are as follows:First, compared with foreign research results, welfare cost of China is bigger than that of foreign country; second, similarly to inflation, deflation will result in welfare cost; third, welfare cost of inflation has non-linear characteristics; fourth, compared with traditional MIU model, the result of interest-bearing money MIU model is smaller than the previous results, which indicates that paying interest to monetary balance can reduce welfare cost; fifth, welfare cost of inflation volatility is very small, which shows that the price level was stable since1996and had little impact on economy.The structure of this paper is as follows:The first chapter introduces background and significance as well as innovations and shortcomings; the second chapter is literature reviews, dividing methods of calculating inflation welfare cost into three parts and introducing each of them, and showing the latest domestic and foreign research results; the third chapter analyzes the reasons of China’s inflation and measures taken by official each time when inflation happen; the fourth chapter describes the interest-bearing money MIU model; the fifth chapter investigates the welfare cost of inflation volatility; and the sixth chapter presents conclusions and policy recommendations.