Research articles >

Incomplete Markets and the Output-Inflation Trade-off

Updated on 15 November 2016 Published

Citation

Algan Yann, Challe Edouard, Ragot Xavier. In: Economic Theory, 46(1), 2011, 55-84.


Abstract

This paper analyses the effects of money shocks on macroeconomic aggregates in a tractable flexible-price, incomplete-markets environment that generates persistent wealth inequalities amongst agents. In this framework, current inflation redistribute wealth from the cash-rich employed to the cash-poor unemployed and induce the former to increase their labour supply in order to maintain their desired levels of consumption and precautionary savings. If the shocks are persistent, however, they also raise inflation expectations and thus deter the employed from saving and supplying labour. We relate the strength of these two inflation taxes to the underlying parameters of the model and study how they compete in determining the overall sign and slope of the implied ‘output-inflation tradeoff’ relation.