Financial Exclusion and Inflation Costs

This paper constructs two models of financial exclusion to assess the welfare costs of inflation. In the first, inflation costs are measured within a classical endowment economy. The second includes a production sector and costly credit. Both models are calibrated to account for inflation costs in a high-inflation economy (developing country) and in a low-inflation economy (developed economy). In an endowment economy, when inflation is reduced from 1.5% to zero in a developed economy, the welfare costs for agents with (without) financial access are 0.36% (1.1%) consumption equivalent variation (CEV). In a model with costly credit, the welfare costs for agents with (without) financial access are 0.7% (1.36%) CEV. For developing countries, when inflation is reduced from 6.2% to zero, the welfare costs for agents with (without) financial access are 1.3% (5%) in an endowment economy. In the costly-credit model, the welfare costs for agents with (without) financial access are 0.44% (6%) CEV. The main finding is that there is a substantial asymmetry in welfare costs between individuals with and without access to financial services, especially in developing countries.