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The Welfare Cost of Inflation Risk Under Imperfect Insurance

Updated on 15 November 2016• Working paper

Citation

Algan Yann, Allais Olivier, Challe Edouard, Ragot Xavier. Working paper. 2016.


Abstract

What are the costs of inflation fluctuations and who bears those costs? In this paper, we investigate this question by means of a quantitative incomplete-market, heterogenous-agent model wherein households hold real and nominal assets and are subject to both idiosyncratic labor income shocks and aggregate inflation risk. Inflation risk is found to generate significant welfare losses for most households, i.e., between 1 and 1.5 percent of permanent consumption. The loss is small or even negative for households at the very top of the productivity and/or wealth distribution. A key feature of our analysis is a nonhomothetic specification for households’ preferences towards money and consumption goods. Unlike traditional specifications, ours allows the model to reproduce the broad features of the distribution of monetary assets (in addition to being consistent with the joint distribution of nonmonetary assets and consumption).