People dislike inflation.  Shiller[1996] provides survey evidence that the public are greatly concerned about inflation and feel strong antipathy towards it. Inflation distresses people because they fear that rising prices will outpace wages. It also angers people because they feel cheated by rising prices. Eighty-five percent of survey respondents report that when they “go to the store and see that prices are higher… [they] sometimes feel a little angry at someone”, the most commonly perceived culprits being the government, manufacturers, store owners, and businesses, and the most commonly identified cause being “greed”.  Kahneman, Knetsch and Thaler [1986] provide survey evidence that consumers find it unfair for prices to increase without underlying increases in marginal costs, for instance in response to higher demand.Campbell [1999] provides additional evidence that consumers’ inferences about the motives behind price increases influence how fair they judge the increase.

In this paper, we incorporate people’s anger about high prices into the standard macroeconomic model of monopolistic competition by Blanchard and Kiyotaki {1987]. To do so, we assume that consumers dislike paying a price that exceeds some fair markup on firms’ marginal costs; fixing a good’s price in real terms, the higher its markup in real terms, the less consumers demand.  When consumers know firms’ marginal costs—and, hence, markups—their distaste for markups makes the economy more competitive but does not change any of its qualitative features. In particular, the supply of money does not affect any real variables. In the more plausible case where consumers do not know marginal costs, their inferences about marginal costs from prices play a pivotal role. We follow a recent literature in behavioral economics by making the extreme yet analytically tractable assumption that consumers infer nothing about marginal costs from prices. Under this assumption, money is no longer neutral. Higher money supply induces lower real markups but higher perceived real markups. Although money supply is expansionary, firms earn lower profits and consumers become angry. Our model also predicts price and real-wage rigidity in response to both supply and demand shocks.

via The Curse of Inflation by Erik Eyster, Kristof Madarasz, and Pascal Michaillati.