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Financial Innovation and the Transactions Demand for Cash

Author

Listed:
  • Fernando Alvarez

    (University of Chicago and NBER)

  • Francesco Lippi

    (University of Sassari, EIEF and CEPR)

Abstract

We document cash management patterns for households that are at odds with the predictions of deterministic inventory models that abstract from precautionary motives. We extend the Baumol-Tobin cash inventory model to a dynamic environment that allows for the possibility of withdrawing cash at random times at a low cost. This modification introduces a precautionary motive for holding cash and naturally captures developments in withdrawal technology, such as the increasing diffusion of bank branches and ATM terminals. We characterize the solution of the model and show that qualitatively it is able to reproduce the empirical patterns. Estimating the structural parameters we show that the model quantitatively 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

  • Fernando Alvarez & Francesco Lippi, 2007. "Financial Innovation and the Transactions Demand for Cash," EIEF Working Papers Series 0807, Einaudi Institute for Economics and Finance (EIEF), revised Sep 2007.
  • Handle: RePEc:eie:wpaper:0807
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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. Thomas F. Cooley & Gary D. Hansen, 1991. "The welfare costs of moderate inflations," Proceedings, Federal Reserve Bank of Cleveland, pages 483-518.
    5. Robert E. Lucas, Jr., 2000. "Inflation and Welfare," Econometrica, Econometric Society, vol. 68(2), pages 247-274, March.
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    7. 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.
    8. 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.
    Full references (including those not matched with items on IDEAS)

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    More about this item

    JEL classification:

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

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