Welfare Costs of Inflation and Imperfect Competition in a Monetary Search Model

In this paper, I quantitatively measure the welfare costs of inflation. I build into standard moneysearch models, such as Rocheteau and Wright(2005) and Lagos and Wright(2005), by introducing endogenous imperfect competition based on free entry decisions that allow for the share of the transaction surplus going to firms to be determined endogenously. Under this framework, the welfare cost of inflation is amplified through a feedback loop, in which restricted money demand reduces the number of firms that the market can support. In turn, this reduction increases market concentration, reduces the consumer surplus, and further decreases the incentives to hold money. I find that, depending on the calibration, between 63 to 90 percent of the estimated welfare costs of inflation can be attributed to the interaction between money holdings and market concentration.