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The welfare cost of inflation revisited: The role of financial innovation and household heterogeneity

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  • Cao, Shutao
  • Meh, Césaire A.
  • Ríos-Rull, José-Víctor
  • Terajima, Yaz

Abstract

The money-consumption ratio increases with age and decreases with consumption, and the recent era of low interest rates has seen a large increase in the aggregate money-consumption ratio. We estimate an overlapping generations model with money for transaction purposes for the age effects and the extent of financial innovation using aggregate and household-level money holdings. We then assess the welfare cost of a 3 percentage point increase in inflation, incorporating the cost from the redistribution of non-money nominal wealth. We find that the welfare costs are 13% of one-year consumption and are borne mostly by the poor and the old.

Suggested Citation

  • Cao, Shutao & Meh, Césaire A. & Ríos-Rull, José-Víctor & Terajima, Yaz, 2021. "The welfare cost of inflation revisited: The role of financial innovation and household heterogeneity," Journal of Monetary Economics, Elsevier, vol. 118(C), pages 366-380.
    • Handle: RePEc:eee:moneco:v:118:y:2021:i:c:p:366-380
    DOI: 10.1016/j.jmoneco.2020.11.004
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    Cited by:

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    2. Sarah Burkinshaw & Yaz Terajima & Carolyn A. Wilkins, 2022. "Income Inequality in Canada," Discussion Papers 2022-16, Bank of Canada.
    3. Edmond Berisha & Orkideh Gharehgozli & Rangan Gupta, 2022. "Inflation-Inequality Puzzle: Is it Still Apparent?," Working Papers 202206, University of Pretoria, Department of Economics.
    4. Mikołaj Raczyński, 2022. "Monetary policy and economic inequality: a literature review," Bank i Kredyt, Narodowy Bank Polski, vol. 53(2), pages 231-278.
    5. Felipe Alves & Christian Bustamante & Xing Guo & Katya Kartashova & Soyoung Lee & Thomas Michael Pugh & Kurt See & Yaz Terajima & Alexander Ueberfeldt, 2022. "Heterogeneity and Monetary Policy: A Thematic Review," Discussion Papers 2022-2, Bank of Canada.

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    More about this item

    Keywords

    Welfare cost of inflation; Financial innovation; Money demand;
    All these keywords.

    JEL classification:

    • E21 - Macroeconomics and Monetary Economics - - Consumption, Saving, Production, Employment, and Investment - - - Consumption; Saving; Wealth
    • E41 - Macroeconomics and Monetary Economics - - Money and Interest Rates - - - Demand for Money

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