Essays on Price and Welfare

This dissertation is a collection of three essays on price and welfare. The first chapter investigates the optimal price index for central banks to stabilize in a model economy where volatile prices are harmful to welfare through monetary friction. The second chapter estimates the impact of recent technological innovation, namely the internet, on the dynamics of prices and welfare through a variety of real mechanisms. The third chapter analyzes the impact of financial regulation on the prices of financial assets and the welfare of the financial market participants. There is currently a debate about what price index central banks should target when economies are open and exposed to international price shocks. Chapter 1 derives the optimal price index by solving the Ramsey problem in a New Keynesian small open economy model with an arbitrary number of sectors. This approach improves on existing theoretical benchmarks because (1) it makes an explicit distinction between the consumer price index (CPI) and the producer price index (PPI), and (2) it allows exogenous international price shocks to play a role. Qualitatively, I use the analytical expression of the optimal price index to discuss that popular indices, such as the PPI and the core/headline CPI, are suboptimal because they ignore the heterogeneity in price stickiness and the effect of inflation on the trade surplus. Quantitatively, I calibrate a 35-sector version of the model for 40 countries and show that stabilizing the optimal price index yields significantly higher welfare than alternative indices. In Chapter 2, which is joint work with Yoon J. Jo and David Weinstein, we estimate the impact of e-commerce on Japanese prices and welfare. First, we consider the possibility that e-commerce may have lowered prices by driving down the average prices of goods available online. Second, we compute the welfare gains due to the ability of e-commerce to enable consumers to purchase goods from other regions. Third, we compute the gains that arise through e-commerce's ability to arbitrage intercity price differences. We find that all three channels produced welfare gains in Japan, but our estimates suggest that the first and second channels are by far the most important, with welfare gains through these channels being eleven to sixteen times larger than through the price arbitrage channel. Overall, we find that increased inter-city arbitrage raised Japanese welfare by 0.12 percent, the gains due to new varieties available through online shopping raised welfare 0.7 percent, and the gains due to overall price reductions for goods available online raised welfare by 1 percent. In Chapter 3, which is joint work with Sakai Ando, we analyze the impact of dealer regulation on price quality (informativeness and volatility) and its implications for the welfare of market participants. We argue that although price informativeness, volatility, and the dealer's profitability all deteriorate, against conventional wisdom, other market participants are better off due to the dealer's risk-shifting motive. A static model is used to clarify the main intuition, and the robustness of the welfare results, as well as the fragility of the conventional wisdom about price quality, are discussed by incorporating dynamics and endogenizing information acquisition.