IDEAS home Printed from https://ideas.repec.org/p/fip/fedlwp/2010-009.html
   My bibliography  Save this paper

Liquidity demand and welfare in a heterogeneous-agent economy

Author

Listed:
  • Yi Wen

Abstract

This paper provides an analytically tractable general-equilibrium model of money demand with micro-foundations. The model is based on the incomplete-market model of Bewley (1980) where money serves as a store of value and provides liquidity to smooth consumption. The model is applied to study the effects of monetary policies. It is shown that heterogeneous liquidity demand can lead to sluggish movements in aggregate prices and positive responses from aggregate output to transitory money injections. However, permanent money growth can be extremely costly: With log utility function and an endogenously determined distribution of money balances that matches the household data, agents are willing to reduce consumption by 8% (or more) to avoid 10% annual inflation. The large welfare cost of inflation arises because inflation destroys the liquidity value and the buffer-stock function of money, thus raising the volatility of consumption for low-income households. The astonishingly large welfare cost of moderate inflation provides a justification for adopting a low inflation target by central banks and offers an explanation for the empirical relationship between inflation and social unrest in developing countries.

Suggested Citation

  • Yi Wen, 2010. "Liquidity demand and welfare in a heterogeneous-agent economy," Working Papers 2010-009, Federal Reserve Bank of St. Louis.
  • Handle: RePEc:fip:fedlwp:2010-009
    as

    Download full text from publisher

    File URL: http://research.stlouisfed.org/wp/2010/2010-009.pdf
    Download Restriction: no

    Citations

    Citations are extracted by the CitEc Project, subscribe to its RSS feed for this item.
    as


    Cited by:

    1. Wen, Yi, 2015. "Money, liquidity and welfare," European Economic Review, Elsevier, vol. 76(C), pages 1-24.
    2. Dressler, Scott, 2016. "A long-run, short-run, and politico-economic analysis of the welfare costs of inflation," Journal of Macroeconomics, Elsevier, vol. 47(PB), pages 255-269.
    3. Chu, Angus C. & Lai, Ching-Chong & Liao, Chih-Hsing, 2010. "A tale of two growth engines: The interactive effects of monetary policy and intellectual property rights," MPRA Paper 30105, University Library of Munich, Germany, revised Apr 2011.
    4. Sunel, Enes, 2010. "On inflation, wealth inequality and welfare in emerging economies," MPRA Paper 25943, University Library of Munich, Germany.

    More about this item

    Keywords

    Liquidity (Economics);

    NEP fields

    This paper has been announced in the following NEP Reports:

    Statistics

    Access and download statistics

    Corrections

    All material on this site has been provided by the respective publishers and authors. You can help correct errors and omissions. When requesting a correction, please mention this item's handle: RePEc:fip:fedlwp:2010-009. See general information about how to correct material in RePEc.

    For technical questions regarding this item, or to correct its authors, title, abstract, bibliographic or download information, contact: (Kathy Cosgrove). General contact details of provider: http://edirc.repec.org/data/frbslus.html .

    If you have authored this item and are not yet registered with RePEc, we encourage you to do it here. This allows to link your profile to this item. It also allows you to accept potential citations to this item that we are uncertain about.

    We have no references for this item. You can help adding them by using this form .

    If you know of missing items citing this one, you can help us creating those links by adding the relevant references in the same way as above, for each refering item. If you are a registered author of this item, you may also want to check the "citations" tab in your RePEc Author Service profile, as there may be some citations waiting for confirmation.

    Please note that corrections may take a couple of weeks to filter through the various RePEc services.

    IDEAS is a RePEc service hosted by the Research Division of the Federal Reserve Bank of St. Louis . RePEc uses bibliographic data supplied by the respective publishers.