On the distributive effects of inflation

This paper proposes a general equilibrium model that aims at quantifying the distributive effects of anticipated inflation in an incomplete market economy with heterogeneous agents. Based on empirical evidence, this paper assumes a fixed cost to participate in financial markets, which in equilibrium generates a theory of money. Money is a return dominated asset, but also a costless mean to smooth consumption for households who in equilibrium decide to remain outside financial markets. In this model, an expansionary monetary policy crowds-in capital (via increased asset market participation), lowers the real interest rate (Mundell Tobin effect) and the insurance effect of capital markets. However, higher money stock growth rate increases lump-sum transfer and lowers interest rates implying higher wages, which improves insurance. I show that higher welfare can be achieved by targeting higher inflation rates, in particular when participation cost are high.