Inflation and Redistribution: Research on the Origins and Implications of Money as a Unit of Account

National Bureau Of Economic Research Inc, Cambridge MA

Investigators

Abstract

Abstract Proposal Title: Inflation and Redistribution: Research on the Origins and Implications of Money as a Unit of Account Proposal Number: SES - 1260961 Principal Investigator: Doepke, Matthias In advanced economies, assets and liabilities that specify future payments (such as mortgages, loans, deposits, and government debt) are usually denominated in fixed nominal units of the local currency. For example, the owner of a U.S. government bond stands to receive a series of interest payments and a principal repayment in fixed dollar terms. Similarly, U.S. fixed-rate mortgage borrowers owe a series of payments that are fixed in dollar terms as well. The use of money as a unit of account for assets and liabilities matters, because it implies that unanticipated changes in the value of the unit of account (i.e., inflation or deflation) lead to wealth redistribution between borrowers and lenders. For example, unanticipated inflation lowers the real value of all nominal assets and liabilities, implying that lenders lose and borrowers gain. The project examines the origins and implications of money's role as a unit of account for assets and liabilities from theoretical and quantitative perspectives. The research has four different components. The first component is theoretical, and aims to explain why economic agents choose to use money as the unit of account for assets and liabilities (as opposed to, say, indexing future payments to inflation). A theory of this kind can also be used to understand the history of the use of money as a unit of account, the role of government debt in promoting the use of money a unified unit of account, and the economics of currency unions. The second component examines the role of redistribution effects for the political economy of inflation, and thereby contributes to a positive theory of inflation. The third component considers the possibility of higher inflation in the United States in the near future, and uses a quantitative general equilibrium model with a rich life-cycle structure to assess the effects of such an inflation shock on macroeconomic aggregates and welfare. The model allows for financial constraints and has an explicit housing market, so that the interaction between inflation and real estate prices can be examined as well. This component of the research will enhance our understanding of the temptation to use inflation to erode government debt, as well as the distributional and macroeconomic implications of such a policy. The last component of the proposed research focuses on the disinflation episode in the United States during the 1980s, and uses panel data from the Survey of Consumer Finances (SCF) to document the impact of surprise deflation on household wealth. Given that individual mortgage histories can be constructed for households in the SCF panel, this research will provide insights into the impact of stabilization policies at the level of individual households, and enhance our understanding of the wider macroeconomic effects of such policies. In sum, the project deepens our understanding of monetary policy and its consequences, as well as the design of monetary institutions and currency systems. The implications for optimal currency areas will help clarify the costs and benefits of a unified currency, an issue which recently has received a lot of attention due to the debt crisis in the Euro zone. The political-economy aspect of the proposal will help clarify the feedback between institutional features of an economy such as the design of the pension system and monetary policy.