Calculation of Welfare Costs of Inflation in Iran

This paper seeks to quantify and measure welfare costs resulting from inflation. In other words, by making use of Iran’s economy data and models related to welfare cost of inflation, this study aims at identifying the relation between inflation and welfare in Iran’s economy.Thus, a money demand function has been defined for Iran’s money market on which the welfare cost of inflation between 1990-2008 has been estimated. First, we investigate the long-term relationship between money to GDP with interest rate for opportunity cost of holding money, by using Dickey-Fuller unit root and Johansson co-integration method. Then, we calculate welfare cost of inflation using consumer’s surplus method and on the basis of the reverse money demand function and Lucas’s logarithmic (2000) as well as Cagan’s semi-logarithmic (1956) patterns for various inflation and interest rates.According to the inflation and interest rate averages in the above mentioned period, namely 19.06 and 18.41 respectively, this study calculates the welfare cost on both logarithmic and semi-logarithmic models as 3.54 and 1.42 to GDP respectively. In addition, inflation welfare cost curve for the mentioned time has been almost without slope and the trend has been stable within both models