Heterogeneity, Decentralized Trade, and the Long-run Real Effects of Inflation

Abstract Real effects of long-run inflation are studied in a standard matching model. The sign and degree of the output-inflation correlation depend on the cause of inflation and, more specifically, on how the underlying policy assigns money among agents. The correlation may be negative and weak and may be positive and strong. Although inflation increases inequality in wealth, whether it increases inequality or the social difference in welfare depends on the underlying policy. The strong and positive output effect can be compatible with a steep and positively sloped Phillips curve. Policy may be chosen in a way that inflation improves both output and ex ante welfare and there is some base for such a policy to be adopted by policy makers.