This paper develops a search-theoretic model to study the interaction between banking and monetary policy and how this interaction affects the allocation and welfare. Regarding how banking affects the welfare costs of inflation: First, we find that, with banking, inflation generates smaller welfare costs. Second, we show that, lowering inflation improves welfare not just by reducing consumption/production distortions, but also by avoiding intermediation costs. Therefore, understanding the nature of intermediation cost is critical for accurately assessing the welfare gain of lowering the inflation target. Regarding how monetary policy affects the welfare effects of banking: First, banking always improves efficiency of production, but the banking technology has to be efficient to improve welfare (especially in low inflation economy). Second, welfare effects of banking depend on monetary policy. For low inflation, banking is not active. For high inflation, banking is active and improves welfare. For moderate inflation, banking is active but reduces welfare. Owing to general equilibrium feedback, banking is supported in equilibrium even though welfare is higher without banking.
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Paper provided by Bank of Canada in its series Working Papers with number
08-49.
Find related papers by JEL classification: E40 - Macroeconomics and Monetary Economics - - Money and Interest Rates - - - General E50 - Macroeconomics and Monetary Economics - - Monetary Policy, Central Banking, and the Supply of Money and Credit - - - General
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References listed on IDEAS Please report citation or reference errors to , or , if you are the registered author of the cited work, log in to your RePEc Author Service profile, click on "citations" and make appropriate adjustments.:
Aleksander Berentsen & Gabriele Camera & Christopher Waller, .
"Money, Credit and Banking,"
IEW - Working Papers
iewwp219, Institute for Empirical Research in Economics - IEW.
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Other versions:
Ping He & Lixin Huang & Randall Wright, 2005.
"Money And Banking In Search Equilibrium,"
International Economic Review,
Department of Economics, University of Pennsylvania and Osaka University Institute of Social and Economic Research Association, vol. 46(2), pages 637-670, 05.
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