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How uncertain are the welfare costs of inflation?

  • Hasan Bakhshi
  • Ben Martin
  • Tony Yates

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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File URL: http://www.bankofengland.co.uk/archive/Documents/historicpubs/workingpapers/2002/wp152.pdf
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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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  1. George A. Akerlof & William R. Dickens & George L. Perry, 1996. "The Macroeconomics of Low Inflation," Brookings Papers on Economic Activity, Economic Studies Program, The Brookings Institution, vol. 27(1), pages 1-76.
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  14. 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.
  15. 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.
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  19. Laurence Ball, 1998. "Another Look at Long-Run Money Demand," NBER Working Papers 6597, National Bureau of Economic Research, Inc.
  20. Goodfriend, Marvin, 1985. "Reinterpreting money demand regressions," Carnegie-Rochester Conference Series on Public Policy, Elsevier, vol. 22(1), pages 207-241, January.
  21. Robert E. Lucas, Jr. & Nancy L. Stokey, 1985. "Money and Interest in a Cash-in-Advance Economy," NBER Working Papers 1618, National Bureau of Economic Research, Inc.
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  27. Saving, Thomas R, 1971. "Transactions Costs and the Demand for Money," American Economic Review, American Economic Association, vol. 61(3), pages 407-20, June.
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  30. G. K. Shaw, 1988. "Keynesian Economics," Books, Edward Elgar Publishing, number 406.
  31. Karni, Edi, 1973. "The Transactions Demand for Cash: Incorporation of the Value of Time into the Inventory Approach," Journal of Political Economy, University of Chicago Press, vol. 81(5), pages 1216-25, Sept.-Oct.
  32. Amemiya, Takeshi, 1974. "The nonlinear two-stage least-squares estimator," Journal of Econometrics, Elsevier, vol. 2(2), pages 105-110, July.
  33. Jag Chadha & Andrew Haldane & Norbert Janssen, 1998. "Shoe-leather costs reconsidered," Bank of England working papers 86, Bank of England.
  34. 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.
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