Seminar

Fairness Concerns, Partial Updating, and the Nonneutrality of Money

Pascal Michaillat (LSE)

September 14, 2015, 17:00–18:30

Macroeconomics Seminar

Abstract

This paper explains the nonneutrality of money from two psychological assumptions: (1) consumers dislike paying prices that exceed some fair markup on firms' marginal costs; and (2) consumers only partially update their beliefs about marginal costs from available information. After an increase in money supply, consumers underappreciate the increase in nominal marginal costs and hence partially misattribute higher prices to higher markups; they perceive transactions as less fair, which increases the price elasticity of their demand for goods; firms respond by reducing markups; in equilibrium, output and employment increase. By raising perceived markups, increased money supply inflicts a psychological cost on consumers that can offset the benefit of increased output.