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How uncertain are the welfare costs of inflation?

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  • Hasan Bakhshi
  • Ben Martin
  • Tony Yates

Abstract

This paper quantifies for the United Kingdom the general equilibrium costs of individuals holding cash to economise on 'shopping time'. These are a subset of a wider range of costs caused by inflation. The paper tests whether or not money balances tend to a finite number as nominal interest rates tend to zero, and investigates how sensitive to this test are the welfare implications of rates of inflation above the Friedman rule (a zero nominal interest rate). The paper then explores how uncertainties about the shape of the money demand curve translate into uncertainties about these welfare costs of inflation. A key uncertainty is the existence of a satiation point for money balances. Using Monte Carlo tests, it is shown that without observations at nominal interest rates very close to zero, the power of satiation tests can be very low. This finding may also be important for evaluating whether/how monetary policy could stabilise the economy in the event of a shock large enough to require that nominal interest rates are driven close to zero.

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Bibliographic Info

Paper provided by Bank of England in its series Bank of England working papers with number 152.

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Date of creation: Feb 2002
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Handle: RePEc:boe:boeewp:152

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References

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  1. Marvin Goodfriend, 2000. "Overcoming the zero bound on interest rate policy," Conference Series ; [Proceedings], Federal Reserve Bank of Boston, pages 1007-1057.
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  7. Allison Holland & Andrew Scott, 1997. "The determinants of UK business cycles," Bank of England working papers 58, Bank of England.
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  18. Holman, Jill A, 1998. "GMM Estimation of a Money-in-the-Utility-Function Model: The Implications of Functional Forms," Journal of Money, Credit and Banking, Blackwell Publishing, vol. 30(4), pages 679-98, November.
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  25. Alexander L. Wolman, 1997. "Zero inflation and the Friedman rule: a welfare comparison," Economic Quarterly, Federal Reserve Bank of Richmond, issue Fall, pages 1-21.
  26. Laidler, David, 1985. "Expectations and adjustment in the monetary sector revisited A comment," Carnegie-Rochester Conference Series on Public Policy, Elsevier, vol. 22(1), pages 243-254, January.
  27. Robert E. Lucas, Jr., 2000. "Inflation and Welfare," Econometrica, Econometric Society, vol. 68(2), pages 247-274, March.
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Cited by:
  1. Claus Brand & Hans-Eggert Reimers & Franz Seitz, 2003. "Narrow Money and the Business Cycle: Theoretical aspects and euro area evdence," Macroeconomics 0303012, EconWPA.

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