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ON THE “HOT POTATO” EFFECT OF INFLATION: INTENSIVE VERSUS EXTENSIVE MARGINS

Published online by Cambridge University Press:  02 June 2011

Lucy Qian Liu ,
Liang Wang  and
Randall Wright
Lucy Qian Liu*
Affiliation:
International Monetary Fund
Liang Wang
Affiliation:
University of Hawaii at Manoa
Randall Wright
Affiliation:
University of Wisconsin and Federal Reserve Bank of Minneapolis
*
Address correspondence to: Lucy Qian Liu, HQ1-06-504, MCD, Division C, International Monetary Fund, 700 19th Street, N.W., Washington, DC 20431, USA; e-mail: QLIU3@imf.org.
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Abstract

Conventional wisdom is that inflation makes people spend money faster, trying to get rid of it like a “hot potato,” and this is a channel through which inflation affects velocity and welfare. Monetary theory with endogenous search intensity seems ideal for studying this. However, in standard models, inflation is a tax that lowers the surplus from monetary exchange and hence reduces search effort. We replace search intensity with a free entry (participation) decision for buyers—i.e., we focus on the extensive rather than intensive margin—and prove buyers always spend their money faster when inflation increases. We also discuss welfare.

Keywords

SearchInflationVelocityFree Entry
Type
Articles
Information
Macroeconomic Dynamics , Volume 15 , Supplement S2: Money, Credit, and Liquidity: Part 2 , September 2011 , pp. 191 - 216
Copyright
Copyright © Cambridge University Press 2011

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