A restatement of the welafare costs of inflation. The wast of scarce resources in the manufacturing , banking and household sectors

Lucas (2000) estimates that the US welfare costs of in‡ation are around 1% of GDP. This measurement is consistent with a speci.c distorting channel in terms of the Bailey triangle under the demand for monetary base schedule (outside money): the displacement of resources from the production of consumption goods to the household transaction time a la Baumol. Here, we consider also several new types of distortions in the manufacturing and banking industries. Our new evidences show that both banks and . rms demand speci.c occupational employments to avoid the in‡ation tax. We de.ne the concept of ”the ‡oat labor”: The occupational employments that are a¤ected by the in‡ation rates. More administrative workers are hired relatively to the bluecollar workers for producing consumption goods. This new phenomenon makes the manufacturing industry more roundabout. To take into account this new stylized fact and others, we redo at same time both ”The model 5: A Banking Sector -2” formulated by Lucas (1993) and ”The Competitive Banking System” proposed by Yoshino (1993). This modelling allows us to characterize better the new types of misallocations. We . nd that the maximum value of the resources wasted by the US economy happened in the years 1980-81, after the 2nd oil shock. In these years, we estimate the excess resources that are allocated for every speci.c distorting channel: i) The US commercial banks spent additional resources of around 2% of GDP; ii) For the purpose of the . rm ‡oating time were used between 2.4% and 4.1% of GDP); and iii) For the household transaction time were allocated between 3.1% and 4.5 % of GDP. The Bailey triangle under the demand for the monetary base schedule represented around 1% of GDP, which is consistent with Lucas (2000). We estimate that the US total welfare costs of in‡ation were around 10% of GDP in terms of the consumption goods foregone. The big di¤erence between our results and Lucas (2000) are mainly due to the Harberger triangle in the market for loans (inside money) which makes part of the household transaction time, of the . rm ‡oat labor and of the distortion in the banking industry. This triangle arises due to the widening interest rates spread in the presence of a distorting in‡ation tax and under a fractionally reserve system. The Harberger triangle can represent 80% of the total welfare costs of in‡ation while the remaining percentage is split almost equally between the Bailey triangle and the resources used for the bank services. Finally, we formulate several theorems in terms of the optimal nonneutral monetary policy so as to compare with the classical monetary theory. Date : May, 2001. Thanks for the critics and comments made by Robert E. Lucas Jr., Larry Sjaastad, Jose A. Scheinkman, Marek Kapicka, Celso Martone, Rodrigo Delosso, the editor and the anonymous referees of Journal of Political Economy, and the participants of the Workshops at USP (Universidade de Sao Paulo Instituto de Pesquisa Economica) and at IPEA (Instituto de Pesquisa Economica Aplicada). Several economists of BEA (Bureau of Economic Analysis), BLS (Bureau of Labor Statistics), Federal Reserve Bank of St. Louis, Federal Reserve Bank of Minneapolis, Federal Reserve Board, and FDIC (Federal Deposit Insurance Corporation) have provided us helpful technical assistance for understanding the US time series that are used in this work. All remaining errors are ours. 1