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Inflation and financial sector size

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  • William B. English
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    Abstract

    Traditionally, the cost of expected inflation has been seen as the "shoeleather cost" of going to the bank more often. This paper focuses on the other side of these transactions--i.e., on the increased production of financial services by financial firms. I construct a model in which households must make purchases either with cash or with costly transactions services produced by firms in the financial services sector. Higher inflation leads households to substitute purchased transactions services for money balances, increasing the size of the financial sector. A test of the model using cross-sectional data suggests that this effect is large.

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    Bibliographic Info

    Paper provided by Board of Governors of the Federal Reserve System (U.S.) in its series Finance and Economics Discussion Series with number 96-16.

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    Date of creation: 1996
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    Handle: RePEc:fip:fedgfe:96-16

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    Keywords: Banks and banking - Customer services ; Inflation (Finance);

    References

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    1. Cooley, T.F. & Hansen, G.D., 1991. "The Welfare Costs of Moderate Inflations," Papers 90-04, Rochester, Business - General.
    2. Harold L. Cole & Alan C. Stockman, 1988. "Specialization, Transactions Technologies, and Money Growth," NBER Working Papers 2724, National Bureau of Economic Research, Inc.
    3. Dotsey, Michael & Ireland, Peter, 1996. "The welfare cost of inflation in general equilibrium," Journal of Monetary Economics, Elsevier, vol. 37(1), pages 29-47, February.
    4. Robert E. Lucas, Jr., 1994. "On the welfare cost of inflation," Working Papers in Applied Economic Theory 94-07, Federal Reserve Bank of San Francisco.
    5. Stanley Fischer, 1993. "The Role of Macroeconomic Factors in Growth," NBER Working Papers 4565, National Bureau of Economic Research, Inc.
    6. Gillman, Max, 1993. "The welfare cost of inflation in a cash-in-advance economy with costly credit," Journal of Monetary Economics, Elsevier, vol. 31(1), pages 97-115, February.
    7. Melvin, Michael, 1988. "The Dollarization of Latin America as a Market-Enforced Monetary Reform: Evidence and Implications," Economic Development and Cultural Change, University of Chicago Press, vol. 36(3), pages 543-58, April.
    8. Liliana Rojas-Suárez, 1992. "Currency Substitution and Inflation in Peru," IMF Working Papers 92/33, International Monetary Fund.
    9. Summers, Robert & Heston, Alan, 1991. "The Penn World Table (Mark 5): An Expanded Set of International Comparisons, 1950-1988," The Quarterly Journal of Economics, MIT Press, vol. 106(2), pages 327-68, May.
    10. Steven B. Kamin & Neil R. Ericsson, 1993. "Dollarization in Argentina," International Finance Discussion Papers 460, Board of Governors of the Federal Reserve System (U.S.).
    11. Schreft, S L, 1992. "Transaction Costs and the Use of Cash and Credit," Economic Theory, Springer, vol. 2(2), pages 283-96, April.
    12. S. Rao Aiyagari & Zvi Eckstein, 1995. "Interpreting monetary stabilization in a growth model with credit goods production," Working Papers 525, Federal Reserve Bank of Minneapolis.
    13. Romer, David, 1986. "A Simple General Equilibrium Version of the Baumol-Tobin Model," The Quarterly Journal of Economics, MIT Press, vol. 101(4), pages 663-85, November.
    14. Stockman, Alan C., 1981. "Anticipated inflation and the capital stock in a cash in-advance economy," Journal of Monetary Economics, Elsevier, vol. 8(3), pages 387-393.
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    Cited by:
    1. Carlos Fernández, 1999. "Inflation and Welfare: An Application to Chile," Latin American Journal of Economics-formerly Cuadernos de Economía, Instituto de Economía. Pontificia Universidad Católica de Chile., vol. 36(107), pages 519-544.
    2. Frederic S. Mishkin, 1998. "Strategies for Controlling Inflation," NBER Working Papers 6122, National Bureau of Economic Research, Inc.
    3. Kenny, Geoff & McGettigan, Donal, 1997. "Low Inflation or Price Stability? A Look at the Issues," Research Technical Papers 3/RT/97, Central Bank of Ireland.
    4. Ragan, Christopher, 1998. "On the Believable Benefits of Low Inflation," Working Papers 98-15, Bank of Canada.
    5. Rahul Dhumale, 2000. "Capital Adequacy Standards: Are They Sufficient?," ESRC Centre for Business Research - Working Papers wp165, ESRC Centre for Business Research.
    6. Boyd, John H. & Levine, Ross & Smith, Bruce D., 2001. "The impact of inflation on financial sector performance," Journal of Monetary Economics, Elsevier, vol. 47(2), pages 221-248, April.
    7. Stanley Fischer, 1996. "Why are central banks pursuing long-run price stability?," Proceedings - Economic Policy Symposium - Jackson Hole, Federal Reserve Bank of Kansas City, pages 7-34.
    8. Jeffrey M. Lacker, 1996. "Stored value cards: costly private substitutes for government currency," Economic Quarterly, Federal Reserve Bank of Richmond, issue Sum, pages 1-25.

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