THE WELFARE COST OF INFLATION IN GENERAL EQUILIBRIUM

This paper presents a general equilibrium monetary model in which infl ation distorts a variety of marginal decisions. Although individually none of the distortions is very large, they combine to yield substanti al welfare cost estimates. A sustained 4 percent inflation like that e xperienced in the US since 1983 costs the economy the equivalent of 0. 41 percent of output per year when currency is identified as the relev ant definition of money and over 1 percent of output per year when M1 is defined as money. The results illustrate how the traditional, parti al equilibrium approach can seriously underestimate the true cost of i nflation.