Money, inflation tax, and trading behavior: Theory and laboratory experiments

Abstract

In a Kiyotaki-Wright model, we generate equilibria characterized by the partial or full acceptability of fiat money and by fundamental or speculative trading strategies. In a laboratory setting with real participants, we then test the model's predictions regarding the effects of an inflation tax and the quantity of money on production and welfare. The inflation tax is implemented through the confiscation of money holdings. Consistent with the model's prediction, the inflation tax reduces the frequency at which players trade a low-storage cost good for fiat money. However, contrary to the model's prediction, we did not observe any significant influence of the inflation tax on trading strategies, suggesting that the inflation tax causes only modest production distortion. We also find that the acceptance of money in the lab is not correlated with the proportion of people holding money. We discuss the welfare consequences of the inflation tax and relate them to the experimental findings based on New Monetarist models.