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Welfare Cost Of Inflation In A General Equilibrium Model With Currency And Interest-Bearing Deposits

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  • JONES, BARRY
  • ASAFTEI, GABRIEL
  • WANG, LIAN

Abstract

We generalize a money-in-the-utility function model to include interest-bearing deposits and use the model to estimate the welfare cost of inflation. In the model, the user cost of deposits is invariant to inflation in steady state. Currency and deposits are assumed to be weakly separable and the model is calibrated using index number methods. We find that the welfare cost of inflation is substantially lower in the model with interest-bearing deposits than in models where all monetary assets are assumed to be non-interest bearing. We also show that higher inflation can raise or lower the rate of convergence to steady state depending on the coefficient of relative risk aversion, but the effect is weak. We provide evidence for OECD countries suggesting that there could be a positive effect of inflation on user costs, which would lead to higher welfare cost estimates.

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Bibliographic Info

Article provided by Cambridge University Press in its journal Macroeconomic Dynamics.

Volume (Year): 8 (2004)
Issue (Month): 04 (September)
Pages: 493-517

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Handle: RePEc:cup:macdyn:v:8:y:2004:i:04:p:493-517_03

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Cited by:
  1. Cysne, Rubens Penha & Turchick, David, 2010. "Money supply and capital accumulation on the transition path revisited," Economics Working Papers (Ensaios Economicos da EPGE) 702, FGV/EPGE Escola Brasileira de Economia e Finanças, Getulio Vargas Foundation (Brazil).
  2. Ryu‐ichiro Murota & Yoshiyasu Ono, 2012. "Zero Nominal Interest Rates, Unemployment, Excess Reserves And Deflation In A Liquidity Trap," Metroeconomica, Wiley Blackwell, vol. 63(2), pages 335-357, 05.
  3. Cysne, Rubens Penha & Turchick, David, 2010. "Welfare costs of inflation when interest-bearing deposits are disregarded: A calculation of the bias," Journal of Economic Dynamics and Control, Elsevier, vol. 34(6), pages 1015-1030, June.
  4. Cysne, Rubens Penha, 2008. "A note on "Inflation and Welfare"," Journal of Banking & Finance, Elsevier, vol. 32(9), pages 1984-1987, September.
  5. Manjong Lee & Sung Guan Yun, 2014. "Composition of Portfolio and Cost of Inflation," Discussion Paper Series 1403, Institute of Economic Research, Korea University.
  6. Michael T. Belongia & Peter N. Ireland, 2010. "The Barnett Critique After Three Decades: A New Keynesian Analysis," Boston College Working Papers in Economics 736, Boston College Department of Economics.
  7. Peter N. Ireland, 2012. "The Macroeconomic Effects of Interest on Reserves," NBER Working Papers 18409, National Bureau of Economic Research, Inc.
  8. Paulo Barelli & Samuel Abreu Pessôa, 2009. "On the general equilibrium costs of perfectly anticipated inflation," Annals of Finance, Springer, vol. 5(2), pages 243-262, March.

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