finance and economics discussion seriesfederal reserve board, washington, d.c.issn 1936-2854 (print)issn 2767-3898 (online)inflation, price dispersion, and welfare: the role of consumersearchfrancisca sara-zaror2024-047please cite this paper as:sara-zaror, francisca (2024). “inflation, price dispersion, and welfare: the role of con-sumer search,” finance and economics discussion series 2024-047. washington: board ofgovernors of the federal reserve system, https://doi.org/10.17016/feds.2024.047.note: staff working papers in the finance and economics discussion series (feds) are preliminarymaterials circulated to stimulate discussion and critical comment. the analysis and conclusions set forthare those of the authors and do not indicate concurrence by other members of the research staff or theboard of governors. references in publications to the finance and economics discussion series (other thanacknowledgement) should be cleared with the author(s) to protect the tentative character of these papers. inflation, price dispersion, and welfare:the role of consumer searchfrancisca sara-zaror∗†‡may 21, 2024abstractin standard macroeconomic models, the costs of inflation are tightly linkedto the price dispersion of identical goods. therefore, understanding how pricedispersion empirically relates to inflation is crucial for welfare analysis. in thispaper, i study the relationship between steady-state inflation and price disper-sion for a cross section of u.s. retail products using scanner data. by comparingprices of items with the same barcode, my measure of relative price dispersioncontrols for product heterogeneity, overcoming an important challenge in the lit-erature. i document a new fact: price dispersion of identical goods increasessteeply around zero inflation and becomes flatter as inflation increases, display-ing aυ-shaped pattern. current sticky-price models are inconsistent with thisfinding. i develop a menu-cost model with idiosyncratic productivity shocks andsequential consumer search that reproduces the new fact and exhibits realisticprice-setting behavior. in the model, inflation-induced price dispersion increasesshoppers’ incentives to search for low prices and thus competition among retailers.the positive welfare-maximizing inflation rate optimally trades off the efficiencygains from lower markups and the resources spent on search.jelcodes: e31, e50, l11, l16.∗federal reserve board. e-mail: francisca.sara-zaror@frb.gov†i am greatly indebted to my co-chairs fernando alvarez and mike golosov, and my dissertationcommittee members greg kaplan and rob shimer, for invaluable advice, support, and encouragementat every stage of this project. i am grateful to agustin hurtado, josh morris-levenson, hyejin park,and marta prato for insightful feedback; to my discussants kieran larkin, gaetano gaballo, andjane ryngaert, as well as participants of the assa 2023, midwest macro meetings 2023, sed 2023,inflation: drivers and dynamics conference 2023, xxv workshop in international economics andfinance, and multiple seminars for helpful comments.‡researcher(s) own analyses calculated (or derived) based in part on data from nielsen consumerllc and marketing databases provided through the nielseniq datasets at the kilts center for mar-keting data center at the university of chicago booth school of business. the conclusions drawnfrom the nielseniq data are those of the researcher(s) and do not reflect the views of nielseniq.nielseniq is not responsible for, had no role in, and was not involved in analyzing and preparing theresults reported herein.1 1 introductiona salient feature of micro-level data is that the prices of identical goods vary acrosssellers. in current macroeconomic models, inflation is a crucial determinant of price dis-persion, and the costs of inflation mainly arise from inflation-induced price dispersion.in this paper, i address three questions: what is the empirical relationship betweeninflation and price dispersion? what does this relationship imply for current monetarytheories? what do we learn for the welfare analysis of inflation?studying how price dispersion empirically relates to inflation imposes several chal-lenges. the first is to measure price dispersion accurately. for this, we need to observethe prices different sellers charge foridenticalgoods. typically, granular datasetswhich have been essential to establish facts on micro-price rigidity do not satisfy thisrequirement. for instance, quotes in the micro-data underlying the cpi are groupedinto product categories with limited information about the specific product being mea-sured or the ability to link identical products across sellers. thus, the comparison ofprices across sellers, even within narrow product categories, would not take productheterogeneity into account (nakamura et al., 2018).i overcome this challenge using highly detailed scanner data for retail products inthe u.s. the dataset contains prices and