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Financial Innovation and the Transactions Demand for Cash

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  • Fernando Alvarez
  • Francesco Lippi

Abstract

We document cash management patterns for households that are at odds with the predictions of deterministic inventory models that abstract from precautionary motives. We extend the Baumol-Tobin cash inventory model to a dynamic environment that allows for the possibility of withdrawing cash at random times at a low cost. This modification introduces a precautionary motive for holding cash and naturally captures developments in withdrawal technology, such as the increasing diffusion of bank branches and ATM terminals. We characterize the solution of the model, which qualitatively reproduces several empirical patterns. We estimate the structural parameters using micro data and show that quantitatively the model captures important economic patterns. The estimates are used to quantify the expenditure and interest rate elasticity of money demand, the impact of financial innovation on money demand, the welfare cost of inflation, and the benefit of ATM ownership. Copyright 2009 The Econometric Society.

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Bibliographic Info

Article provided by Econometric Society in its journal Econometrica.

Volume (Year): 77 (2009)
Issue (Month): 2 (03)
Pages: 363-402

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Handle: RePEc:ecm:emetrp:v:77:y:2009:i:2:p:363-402

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  1. Humphrey, David B., 2004. "Replacement of cash by cards in US consumer payments," Journal of Economics and Business, Elsevier, vol. 56(3), pages 211-225.
  2. Lippi, Francesco & Secchi, Alessandro, 2006. "Technological change and the demand for currency: An analysis with household data," CEPR Discussion Papers 6023, C.E.P.R. Discussion Papers.
  3. Cooley, Thomas F & Hansen, Gary D, 1991. "The Welfare Costs of Moderate Inflations," Journal of Money, Credit and Banking, Blackwell Publishing, vol. 23(3), pages 483-503, August.
  4. Orazio Attanasio & Luigi Guiso & Tuillo Jappelli, 1998. "The Demand for Money, Financial Innovation, and the Welfare Cost of Inflation: An Analysis with Household Data," NBER Working Papers 6593, National Bureau of Economic Research, Inc.
  5. Luca Casolaro & Leonardo Gambacorta & Luigi Guiso, 2005. "Regulation, formal and informal enforcement and the development of the household loan market. Lessons from Italy," Temi di discussione (Economic working papers) 560, Bank of Italy, Economic Research and International Relations Area.
  6. Jacob A. Frenkel & Boyan Jovanovic, 1981. "On Transactions and Precautionary Demand For Money," NBER Working Papers 0288, National Bureau of Economic Research, Inc.
  7. Robert E. Lucas, Jr., 2000. "Inflation and Welfare," Econometrica, Econometric Society, vol. 68(2), pages 247-274, March.
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