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Optimal money demand in a heterogeneous-agent cash-in-advance economy

  • Yi Wen
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Heterogeneity matters. This point is illustrated in a heterogeneous-agent, cash-in-advance economy where money serves both as a medium of exchange and as a store of value (as in Lucas, 1980). It is shown that heterogeneity can lead to dramatically different implications of monetary policies from those under the representative-agent assumption, including (i) the velocity of money is not constant but highly volatile, as in the data; (ii) lump-sum transitory money injections have expansionary effects on aggregate output despite flexible prices; and (iii) the welfare cost of anticipated inflation is potentially a couple of orders larger than the estimates of Cooley and Hansen (1989) based on a representative-agent, cash-in-advance economy.

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Paper provided by Federal Reserve Bank of St. Louis in its series Working Papers with number 2010-014.

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Date of creation: 2010
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Handle: RePEc:fip:fedlwp:2010-014
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