Inflation, Redistribution, and Real Activities

Empirical evidence suggests that inflation has positive effect on both output and unemployment in the long run in the United States. This paper develops a monetary model in which a higher inflation rate increases both output and unemployment. The model has two key features: (i) separation between workers and owners of firms (employers) and (ii) endogenous labor force participation. Changes in money supply redistributes consumption between employers and workers. This redistribution along with endogenous labor force participation creates a channel by which a higher inflation rate increases output, unemployment, and labor force participation. The Friedman rule does not maximize social welfare.