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Cash, Checkable Deposits and Cost of Inflation

Author

Listed:
  • Manjong Lee

    (Department of Economics, Korea University)

  • Sung Guan Lee

    (Payment & Settlement Systems Department, The Bank of Korea)

Abstract

The Welfare cost of inflation is revisited with a search-theoretic model wherein distinct features of cash and checkable deposits as means of payment are incorporated. Our result implies that the presence of an interest-bearing checkable deposit amplifies the cost of inflation significantly via a channel of option value of money. Put differently, the cost of inflation is substantially underestimated under the assumption of non-interest-bearing M1. This is in stark contrast to the previous studies in which the assumption of non-interest-bearing M1 leads to a considerable overvaluation of an inflation cost. This finding provides the rationale for a low inflation target by the central bank where the payment system is highly developed.

Suggested Citation

  • Manjong Lee & Sung Guan Lee, 2013. "Cash, Checkable Deposits and Cost of Inflation," Working Papers 2013-3, Economic Research Institute, Bank of Korea.
    • Handle: RePEc:bok:wpaper:1303
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    More about this item

    Keywords

    cash; interest-bearing checkable deposit; cost of inflation;
    All these keywords.

    JEL classification:

    • E31 - Macroeconomics and Monetary Economics - - Prices, Business Fluctuations, and Cycles - - - Price Level; Inflation; Deflation
    • E41 - Macroeconomics and Monetary Economics - - Money and Interest Rates - - - Demand for Money
    • E51 - Macroeconomics and Monetary Economics - - Monetary Policy, Central Banking, and the Supply of Money and Credit - - - Money Supply; Credit; Money Multipliers

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