The Welfare Costs of Inflation Reconsidered

Modern analysis of the welfare effects of monetary policy is based on moneyless models and therefore ignores the effect of inflation on the efficiency of transactions. A justification for this strategy is that these welfare effects are quantitatively very small, as argued by Ireland (2009). We revisit Ireland's result using recent data for the United States and several other developed countries. Our computations are influenced by the experience of very low short-term rates observed since Ireland's work in the countries we study. We estimate the welfare cost of a steady state nominal interest rate of 5% to be at least one order of magnitude higher than in Ireland (2009), which questions the validity of performing monetary policy evaluation in cashless models.