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Financial Innovation and the Transactions Demand for Cash

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  • Alvarez, Fernando
  • Lippi, Francesco

Abstract

We extend the Baumol-Tobin cash inventory model to a dynamic environment, which allows for the possibility of withdrawing cash at random times at a low cost. This modification captures developments in withdrawal technology, such as the increasing diffusion of bank branches and ATM terminals. We document cash management patterns for households that are at odds with the predictions of deterministic inventory models that abstract from precautionary motives. We characterize the solution of the model and show that qualitatively it is able to reproduce such patterns. Estimating the structural parameters we show that the model accounts for key features of the data. The estimates are used to quantify the expenditure and interest rate elasticity of money demand, the impact of financial innovation on money demand, the welfare cost of inflation, the gains of disinflation and the benefit of ATM ownership.

Suggested Citation

  • Alvarez, Fernando & Lippi, Francesco, 2007. "Financial Innovation and the Transactions Demand for Cash," CEPR Discussion Papers 6472, C.E.P.R. Discussion Papers.
  • Handle: RePEc:cpr:ceprdp:6472
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    References listed on IDEAS

    as
    1. Humphrey, David B., 2004. "Replacement of cash by cards in US consumer payments," Journal of Economics and Business, Elsevier, vol. 56(3), pages 211-225.
    2. Lippi, Francesco & Secchi, Alessandro, 2006. "Technological change and the demand for currency: An analysis with household data," CEPR Discussion Papers 6023, C.E.P.R. Discussion Papers.
    3. Orazio P. Attanasio & Luigi Guiso & Tullio Jappelli, 2002. "The Demand for Money, Financial Innovation, and the Welfare Cost of Inflation: An Analysis with Household Data," Journal of Political Economy, University of Chicago Press, vol. 110(2), pages 317-351, April.
    4. Jacob A. Frenkel & Boyan Jovanovic, 1980. "On Transactions and Precautionary Demand for Money," The Quarterly Journal of Economics, Oxford University Press, vol. 95(1), pages 25-43.
    5. Thomas F. Cooley & Gary D. Hansen, 1991. "The welfare costs of moderate inflations," Proceedings, Federal Reserve Bank of Cleveland, pages 483-518.
    6. Luca Casolaro & Leonardo Gambacorta & Luigi Guiso, 2005. "Regulation, formal and informal enforcement and the development of the household loan market. Lessons from Italy," Temi di discussione (Economic working papers) 560, Bank of Italy, Economic Research and International Relations Area.
    7. Robert E. Lucas, Jr., 2000. "Inflation and Welfare," Econometrica, Econometric Society, vol. 68(2), pages 247-274, March.
    8. George M. Constantinides & Scott F. Richard, 1978. "Existence of Optimal Simple Policies for Discounted-Cost Inventory and Cash Management in Continuous Time," Operations Research, INFORMS, vol. 26(4), pages 620-636, August.
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    More about this item

    Keywords

    inventory models; money demand; technological progress;
    All these keywords.

    JEL classification:

    • E5 - Macroeconomics and Monetary Economics - - Monetary Policy, Central Banking, and the Supply of Money and Credit

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