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Sticky-price models often suggest that relative price distortion is a major cost of inflation. We provide an intuition for this: Even at low rates, inflation strongly affects price dispersion which in turn has an impact on the economy qualitatively similar to, and of the order of magnitude of, a negative shift in productivity. The utility cost of price dispersion is quantified and its impact on optimal monetary policy discussed. Price dispersion is incorporated into a linearised model. Strikingly, a contractionary nominal shock has a persistent, negative hump-shaped impact on inflation but may have a positive hump-shaped impact on output.This article investigates the macroeconomic implications of relative price distortions as this is where many, though not all, sticky-price models locate the costs of inflation. 1 First, we quantify how costly price dispersion is in a standard macroeconomic model with imperfect competition and price rigidity as in Calvo (1983). Despite being very costly in welfare terms, price dispersion is generally considered to be a term of secondorder importance in linearised models. That is why many economists conclude that the direct impact of price dispersion on welfare is small (Canzoneri et al., 2004). However, in economies with, say, trend inflation of 2-3%, no indexation and a degree of nominal price inertia, price dispersion, viewed through the lens of our simple model, will be an important (first-order) variable. The key margins that are distorted by price dispersion are identified and we develop what we think is a useful intuition on the costs of dispersion which has not been identified hitherto: price dispersion impacts on the economy like a negative productivity shock and so inflation surprises are far from costless in this set-up.

This article examines the determinants of tax non-compliance when we recognise the existence of an imperfectly competitive "tax advice" industry supplying schemes which help taxpayers reduce their tax liability. We apply a traditional industrial organisation framework to model the behaviour of this industry. This tells us that an important factor determining the equilibrium price and hence, the level of noncompliance, is the convexity of the demand schedule. We show that in this context, this convexity is a¤ected by the distribution of pre-tax income, the progressivity of the tax-schedule and the way in which monitoring and penalties vary with income. It is shown that lower pre-tax income inequality as well as a less progressive tax code may cause more tax minimisation activities. Therefore, the frequently advocated policy of reducing the highest tax rate may fail as a policy directed at improving tax discipline. One way of o¤setting the possible harm to tax compliance from a less progressive tax could be an adjustment of the penalty and monitoring functions.JEL Classi…cation: H21; H23; H26

Many sticky-price models suggest that relative price distortion is one of the major costs of inflation. We show that this resource misallocation is costly even at quite low rates of inflation. This is because inflation strongly affects price dispersion which in turn has an impact on the economy qualitatively similar to, and of the order of magnitude of, a negative shift in productivity. Similarly, the utility cost of price dispersion is large. We incorporate price dispersion in a linearized model. This radically affects how shocks are transmitted through the economy. Notably, a contractionary nominal shock has a persistent, negative hump-shaped impact on inflation, but may have a positive hump-shaped impact on output. Observed persistence in the policy rate is not due to the policy rule per se. JEL Classification: E52; E61; E63.

Less is known about social welfare objectives when it is costly to change prices, as in Rotemberg (1982), compared with Calvo-type models. We derive a quadratic approximate welfare function around a distorted steady state for the costly price adjustment model. We highlight the similarities and differences to the Calvo setup. Both models imply inflation and output stabilization goals. It is explained why the degree of distortion in the economy influences inflation aversion in the Rotemberg framework in a way that differs from the Calvo setup.JEL Classification: E52, E61, E63.