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Composition of Portfolio and Cost of Inflation

Author

Listed:
  • Manjong Lee

    (Department of Economics, Korea University, Seoul, Republic of Korea)

  • Sung Guan Yun

    (Payment and Settlement Systems Department, Bank of Korea, Republic of Korea)

Abstract

The welfare cost of inflation is explored via a search-theoretic model in which along with non-interest-bearing cash, interest-bearing liquid and illiquid assets are available. With inflation, agents are willing to replace higher-return illiquid assets with lower return liquid assets for consumption purchases. The opportunity cost incurred by this adjustment turns out to have quantitatively significant implications on the cost of inflation. A parameterized version of the model suggests that the cost of 10% inflation with liquid and illiquid interest-bearing assets is almost 3 times larger than that in a cash-only model. This implies that most existing measures of inflation cost with narrow money are substantially underestimated.

Suggested Citation

  • Manjong Lee & Sung Guan Yun, 2014. "Composition of Portfolio and Cost of Inflation," Discussion Paper Series 1403, Institute of Economic Research, Korea University.
    • Handle: RePEc:iek:wpaper:1403
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    File URL: http://econ.korea.ac.kr/~ri/WorkingPapers/w1403.pdf
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    References listed on IDEAS

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    Keywords

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    JEL classification:

    • E31 - Macroeconomics and Monetary Economics - - Prices, Business Fluctuations, and Cycles - - - Price Level; Inflation; Deflation
    • E40 - Macroeconomics and Monetary Economics - - Money and Interest Rates - - - General
    • E50 - Macroeconomics and Monetary Economics - - Monetary Policy, Central Banking, and the Supply of Money and Credit - - - General

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