Inside money and the effects of inflation

This paper studies inflation in a model of inside money, where inside money is a debt instrument that shares the same liquidity properties as outside money. The explicit modeling of inside money allows for the standard Tobin effect of inflation to be combined with the transaction costs of inflation. Thus the net effect of inflation may be positive, negative, or zero. However, it is demonstrated that if the net effect is positive, it is likely to be small in magnitude and appear only at small inflation. Furthermore, numerical simulations reveal that the net effect may be substantially negative for even moderate inflation. These results are consistent with empirical observations.