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The Demand for Money, Financial Innovation and the Welfare Cost of Inflation: An Analysis with Households' Data

  • Attanasio, Orazio
  • Guiso, Luigi
  • Jappelli, Tullio

How far can shoe-leather go in explaining the welfare cost of inflation? Using a unique set of microeconomic data on households, we estimate the parameters of the demand for money derived from a generalized Baumol-Tobin model. Our data set contains information on average holdings of cash, on deposits and other interest bearing accounts, on the number of trips to the bank, on the size of withdrawals and on the ownership and use of ATM cards. We model the adoption of new transaction technologies and use these estimates to correct for the selectivity bias induced by some households choosing to hold no interest bearing assets and some using an ATM card. The interest rate and expenditure flow elasticities of the demand for cash are close to the theoretical values implied by standard inventory models. We find significant differences, however, between the individuals with an ATM card and those without. The estimates of the demand for cash allow us to calculate a measure of the welfare cost of inflation analogous to Bailey’s triangle, but based on a rigorous microeconometric framework. The welfare cost of inflation varies considerably within the population, but never turns out to be very large (about 0.1% of consumption or less). Our results are robust to various changes in the specification. In addition to the main results based on the average stock of cash held, we provide some evidence based on the number of trips to the bank and on the average withdrawals that confirm our basic findings.

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Paper provided by C.E.P.R. Discussion Papers in its series CEPR Discussion Papers with number 1927.

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Date of creation: Jul 1998
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Handle: RePEc:cpr:ceprdp:1927
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  1. Mulligan, Casey B, 1997. "Scale Economies, the Value of Time, and the Demand for Money: Longitudinal Evidence from Firms," Journal of Political Economy, University of Chicago Press, vol. 105(5), pages 1061-79, October.
  2. Casey B. Mulligan & Xavier Sala-i-Martin, 2000. "Extensive Margins and the Demand for Money at Low Interest Rates," Journal of Political Economy, University of Chicago Press, vol. 108(5), pages 961-991, October.
  3. James Bullard & Steven Russell, 1998. "How costly is sustained low inflation for the U.S. economy?," Working Papers 1997-012, Federal Reserve Bank of St. Louis.
  4. Case M. Sprenkle, 1993. "The Case of the Missing Currency," Journal of Economic Perspectives, American Economic Association, vol. 7(4), pages 175-184, Fall.
  5. Michael Dotsey & Peter Ireland, 1994. "The welfare cost of inflation in general equilibrium," Working Paper 94-04, Federal Reserve Bank of Richmond.
  6. Gomme, P., 1993. "Money and Growth Revisited : Measuring the Costs of Inflation in an Endogenous Growth Model," Discussion Papers dp93-03, Department of Economics, Simon Fraser University.
  7. Paul Gomme, 1991. "Money and growth revisited," Discussion Paper / Institute for Empirical Macroeconomics 55, Federal Reserve Bank of Minneapolis.
  8. Bomberger, William A, 1993. "Income, Wealth, and Household Demand for Deposits," American Economic Review, American Economic Association, vol. 83(4), pages 1034-44, September.
  9. Cooley, T.F. & Hansen, G.D., 1988. "The Inflation Tax In A Real Business Cycle Model," Papers 88-05, Rochester, Business - General.
  10. Ramon Marimon & Juan Pablo Nicolini & Pedro Teles, 1997. "Electronic money: the end of inflation?," Discussion Paper / Institute for Empirical Macroeconomics 122, Federal Reserve Bank of Minneapolis.
  11. Casey B. Mulligan & Xavier X. Sala-i-Martin, 1997. "The Optimum Quantity of Money: Theory and Evidence," NBER Working Papers 5954, National Bureau of Economic Research, Inc.
  12. Robert E. Lucas, Jr., 2000. "Inflation and Welfare," Econometrica, Econometric Society, vol. 68(2), pages 247-274, March.
  13. Casey B. Mulligan & Xavier Sala-i-Martin, 1996. "Adoption of Financial Technologies: Implications for Money Demand and Monetary Policy," NBER Working Papers 5504, National Bureau of Economic Research, Inc.
  14. Martin Feldstein, 1996. "The Costs and Benefits of Going from Low Inflation to Price Stability," NBER Working Papers 5469, National Bureau of Economic Research, Inc.
  15. Fischer, Stanley, 1981. "Towards an understanding of the costs of inflation: II," Carnegie-Rochester Conference Series on Public Policy, Elsevier, vol. 15(1), pages 5-41, January.
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