The efficiency of financial markets with high inflation

Abstract

In a two period general equilibrium model with incomplete asset markets, it is shown that the contraction of nominal financial markets that occurs during high inflations can result from the variability of the future rate of inflation and from large bankruptcy costs. If the probability that inflation in the future will be high is sufficiently large, then, for a generic set of endowments, an increase in the variability of future prices reduces the utility possibilities set. In economies with only nominal assets more variable future prices lead to a Pareto fall in social welfare.