Monetary Policy, Price Dynamics, and Welfare

We present a micro-founded search-theoretical model of money in which agents are subject to idiosyncratic liquidity shocks as well as aggregate productivity and monetary shocks. Monetary policy has redistributive effects and persistent effects on output and prices: aggregate shocks will propagate and diffuse gradually as the money distribution adjusts over time. The model is used to study its cyclical properties, the welfare costs of unanticipated inflation, the short-run (real) effects of unanticipated monetary shocks, and to evaluate the welfare of different monetary policy rules. An algorithm based on the one proposed by Algan, Allais, and den Haan (2007) is presented and used to solve the model.