The cost of inflation: A mechanism design approach

I apply mechanism design to quantify the cost of in‡ation that can be attributed to monetary frictions alone. In an environment with pairwise meetings, the money demand that is consistent with an optimal, incentive feasible allocation takes the form of a continuous correspondence that can …t the data over the period 1900-2006. For such parameterizations, the cost of moderate in‡ation is zero. This result is robust to the introduction of match-speci…c heterogeneity and endogenous participation decisions. JEL Classi…cation: D82, D83, E40, E50