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Financial Innovation and the Transactions Demand for Cash

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  • Fernando E. 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 and show that qualitatively it is able to reproduce the empirical patterns. Estimating the structural parameters we show that the model quantitatively 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 National Bureau of Economic Research, Inc in its series NBER Working Papers with number 13416.

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Date of creation: Sep 2007
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Publication status: published as Fernando Alvarez & Francesco Lippi, 2009. "Financial Innovation and the Transactions Demand for Cash," Econometrica, Econometric Society, vol. 77(2), pages 363-402, 03.
Handle: RePEc:nbr:nberwo:13416

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  1. 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).
  2. 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.
  3. Jacob A. Frenkel & Boyan Jovanovic, 1981. "On Transactions and Precautionary Demand For Money," NBER Working Papers 0288, National Bureau of Economic Research, Inc.
  4. 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.
  5. Attanasio, Orazio & Guiso, Luigi & Jappelli, Tullio, 1998. "The Demand for Money, Financial Innovation and the Welfare Cost of Inflation: An Analysis with Households' Data," CEPR Discussion Papers 1927, C.E.P.R. Discussion Papers.
  6. 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.
  7. Robert E. Lucas, Jr., 2000. "Inflation and Welfare," Econometrica, Econometric Society, vol. 68(2), pages 247-274, March.
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