This proposal outlines research on the redistribution effects of inflation. Redistribution of real wealth is an immediate consequence of any unanticipated change in the price level. Inflation lowers the real value of nominal assets and liabilities, and thereby shifts wealth from lenders to borrowers. Existing studies have focused on the revaluation of government debt. The research described in this proposal considers the revaluation of all nominal assets and liabilities in the economy. The goal is to provide a comprehensive quantitative assessment of the redistribution effects of inflation, as well as their implications for macroeconomic aggregates and welfare.

The intellectual merit of the proposed activity is that it enhances our understanding of the real effects of inflation. The proposal achieves this objective by employing two analytical tools. The first is an empirical framework used to document exposure to inflation risk in the United States, for different sectors as well as age and wealth groups of households. The framework combines sectoral data from the Flow of Funds Accounts, household-level data from the Survey of Consumer Finances, as well as data on the payoff structure and market prices of nominal assets to construct a consistent array of nominal positions. To gauge the duration of these positions, future payment streams are estimated by date, agent, and type of nominal instrument. The second tool is a dynamic general equilibrium model that can be used to assess the economic effects of redistribution shocks. The model allows for heterogeneity along the same dimensions as the data; it is calibrated to match key macroeconomic aggregates as well as properties of the wealth and income distribution. It can also accommodate various fiscal policy scenarios that may arise in response to an inflation episode. The proposal describes an application that uses the tools to quantify the wealth redistribution that would occur if the United States were to enter another moderate inflation episode similar to that of the 1970s. This application leads to three main results. First, even moderate inflation can cause a sizable redistribution of wealth. The main winners from inflation would be the government and young households with mortgage debt, while the main losers would be old households and, in light of the recent surge in foreign debt, foreigners. Second, the model shows that the responses of losers (old lenders) and winners (young borrowers) do not cancel out, so that redistribution due to inflation has aggregate effects. The magnitude of these effects is comparable to those in representative-agent models with monetary frictions, but the effects arising from redistribution persist long after the end of the inflation episode. Third, the welfare effect on domestic households is the opposite of what standard monetary models generate: inflation-induced redistribution has a positive effect on the weighted aggregate welfare. Overall, the application demonstrates that redistribution is an important channel for the impact of inflation on household behavior, economic aggregates, and welfare.

The broader impact of the proposed research derives from its implications for monetary policy, as well as the design of institutions that help control inflation. The existing application shows that households have important reasons to disagree about monetary policy. The proposal describes a number of additional policy applications. First, the setup will be used to assess the redistribution effects of stabilization policy. Here the objective is to quantify the wealth effects of U.S. monetary policy in the 1980s. A second extension will explore the political economy implications of the findings. The existing results show that there are circumstances such that a majority of households stands to gain from inflation-induced redistribution. Moreover, the fiscal policy package that accompanies an inflationary episode is a key factor in shaping public support for inflation policies. The proposal outlines an empirical investigation of the degree to which redistribution concerns can explain the emergence of historical episodes of high inflation, as well as an extended theoretical analysis of the political economy of inflation.

Agency
National Science Foundation (NSF)
Institute
Division of Social and Economic Sciences (SES)
Application #
0519013
Program Officer
Daniel H. Newlon
Project Start
Project End
Budget Start
2005-08-01
Budget End
2008-12-31
Support Year
Fiscal Year
2005
Total Cost
$135,246
Indirect Cost
Name
New York University
Department
Type
DUNS #
City
New York
State
NY
Country
United States
Zip Code
10012