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Financial Innovation and the Transactions Demand for Cash

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  • Alvarez, Fernando E
  • Lippi, Francesco

Abstract

We extend the Baumol-Tobin cash inventory model to a dynamic environment, which allows for the possibility of withdrawing cash at random times at a low cost. This modification captures developments in withdrawal technology, such as the increasing diffusion of bank branches and ATM terminals. We document cash management patterns for households that are at odds with the predictions of deterministic inventory models that abstract from precautionary motives. We characterize the solution of the model and show that qualitatively it is able to reproduce such patterns. Estimating the structural parameters we show that the model accounts for key features of the data. 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, the gains of disinflation and the benefit of ATM ownership.

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Bibliographic Info

Paper provided by C.E.P.R. Discussion Papers in its series CEPR Discussion Papers with number 6472.

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Date of creation: Sep 2007
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Handle: RePEc:cpr:ceprdp:6472

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Keywords: inventory models; money demand; technological progress;

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  1. Orazio Attanasio & Luigi Guiso & Tullio Jappelli, 1998. "The Demand for Money, Financial Innovation, and the Welfare Cost of Inflation: An Analysis with Households' Data," CSEF Working Papers 03, Centre for Studies in Economics and Finance (CSEF), University of Naples, Italy.
  2. 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.
  3. Cooley, T.F. & Hansen, G.D., 1991. "The Welfare Costs of Moderate Inflations," RCER Working Papers 266, University of Rochester - Center for Economic Research (RCER).
  4. Robert E. Lucas, Jr., 2000. "Inflation and Welfare," Econometrica, Econometric Society, vol. 68(2), pages 247-274, March.
  5. 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.
  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. Francesco Lippi & Alessandro Secchi, 2008. "Technological change and the demand for currency: An analysis with household data," Temi di discussione (Economic working papers) 697, Bank of Italy, Economic Research and International Relations Area.
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