Abstract:
This paper examines quantitative properties of the transitional dynamics
produced by gradual disinflation. The main exercise is to feed the empirically
observed declining path for inflation into a calibrated heterogeneous
agents model with incomplete markets and account for its macroeconomic, distributional
and welfare effects under alternative fiscal arrangements. The results show that (i) when
uniform transfers are endogenous, gradual decline in the inflation rate from 14.25% to 2.25%
increases aggregate welfare by 0.28%. (ii) When wasteful spending is endogenous, aggregate welfare
increases by 0.53%. These welfare effects are substantially different from those
implied by steady state comparisons. This is because when transition is accounted for,
fiscal variables that create strong wealth effects do not jump to their low inflation steady
state levels immediately.