Abstract:
This study investigates the distributional and welfare consequences of disinflation
in emerging economies using a monetary model of a small open economy with
uninsured idiosyncratic earnings risk. The model is calibrated to Turkish data and
is used to compare stationary equilibria with quarterly inflation rates of 14.25%
(for 1987:Q1-2002:Q4) and 2.25% (for 2003:Q1- 2010:Q2). Reduction in inflationary
finance is assumed to affect lump-sum transfers, since government spending-to-GDP
ratios have been roughly stable during disinflation in a number of emerging economies.
Disinflation is found to lower aggregate welfare by 1.23% in terms of compensating
consumption variation. This is because the reduction in the distortionary impediments of
inflation on the poor falls short of the decline in their redistributive transfers income that
is mainly financed by the rich. The shrinkage of cash transfers also tightens natural debt
limits and increases the precautionary savings motive.