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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. Croushore, Dean, 1993. "Money in the utility function: Functional equivalence to a shopping-time model," Journal of Macroeconomics, Elsevier, vol. 15(1), pages 175-182.
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  19. Robert G. King & Alexander L. Wolman, 1996. "Inflation targeting in a St. Louis model of the 21st century," Review, Federal Reserve Bank of St. Louis, issue May, pages 83-107.
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  29. Amemiya, Takeshi, 1974. "The nonlinear two-stage least-squares estimator," Journal of Econometrics, Elsevier, vol. 2(2), pages 105-110, July.
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