The Welfare Cost of Inflation : Theory with an Application of Generalized Method of Moments (GMM) to Iran

This paper empirically investigates the welfare cost of inflation in a money in utility function (miuf) model. in order to do this, as in modem monetary theory, dynamic optimizing framework of a representative agent is used. this optimization process yields a. system of stochastic nonlinear euler equations that show the agent's choices. the empirical analysis employs the generalized method of moments (gmm) technique to estimate the parameters of the system by using annual data for iran, 1970-2000. the structural parameters recovered from the estimation of the euler equations of the model are statistically significant and economically meaningful. the results of this study confirm that the representative agent model fits the consumption and money data well. we find for low rate of inflation welfare cost markedly increases with increase in inflation but rapidly reaches an asymptote, that is the welfare cost of high inflation is 7 percent of gdp. the results show that the welfare loss due to an increase in the inflation from zero to 10 percent is equivalent to a decrease in real gdp over than 2 percent, more than twice as big as lucas' (2000) estimate for u. s.in this study, the implication of model about seigniorage is investigated too; our empirical finding in this regard indicates the stability of seigniorage to gdp ratio despite of wide fluctuation in the rate of inflation