Costs of Price Adjustment and the Welfare Economics of Inflation and Disinflation

Abstract

This paper studies the welfare consequences of inflation and disinflation in a model in which monopol istic firms incur a fixed cost of price adjustment. It is shown that a moderately increasing price level is associated with higher social welfare than a perfectly stable price level, and the model therefore provides theoretical support for the widespread belief that a little bit of inflation is good for the economy. Nevertheless, it is also tr ue that the eradication of a moderate inflation leads to an increase in social welfare. Copyright 1988 by American Economic Association.

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