On The Hot PotatoE¤ect of Ination

Conventional wisdom is that in‡ation makes people spend their money faster, trying to get rid of it like a “hot potato.” Intuitively, this is one channel through which in‡ation increases velocity in theory (as in the data). Search-based monetary models seem ideal for studying this phenomenon. However, in the standard model, in‡ation acts like a tax, lowering the surplus associated with monetary exchange and hence buyers’ search e¤ort. Question: what kind of theory would predict buyers trade faster when the surplus is lower? Answer: One with free entry. We prove that buyers must spend their money faster when in‡ation increases if they are faced with the natural free-entry or participation condition. We thank Guillaume Rocheteau, Ricardo Lagos, Miguel Molico, Jonathon Chiu and seminar participants at Penn, the Federal Reserve Bank of Cleveland, and the Bank of Canada for their input. Wright thanks the NSF. The usual disclaimer applies.