Inflation and the Dispersion of Real Wages
 
This paper analyzes the effects of inflation on real wage dispersion and welfare in a cash-in-advance economy with a Walrasian goods market but a labor market with search friction in which firms enjoy monopsony power. In the labor market, the firms post wages and both the employed and the unemployed workers search among the posted wages. In equilibrium, a higher inflation rate reduces the dispersion in real wages.  This result  is consistent with both the observed trends in wage dispersion and the inflation rate witnessed in the 1980s and the 1990s  in the U.S. and  the empirical literature linking reduced inflation to greater wage dispersion. Higher inflation also lowers consumption, output, vacancies, and employment. Moreover, the optimal inflation rate exceeds the Friedman rule.