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On the Welfare Cost of Inflation: The Case of Pakistan

  • Mushtaq, Siffat
  • Rashid, Abdul
  • Qayyum, Abdul

In this study we quantified the welfare cost of inflation from the estimated long-run money demand functions for Pakistan for the period 1960-2007 using cointegration approach. The empirical results show that all the monetary aggregates are negatively related to the interest rate. The welfare gain of moving from positive inflation to zero inflation is approximately same under both money demand specifications but the behavior of the two models is different towards low interest rates. Moving from zero inflation to zero nominal interest rate has substantial gain under log-log form compared to the semi-log function. Compensating variation approach for the semi-log model gives higher welfare loss figures compared to the Bailey’s approach due to the quadratic nature of nominal interest rate in the Lucas (2000) welfare measure. However, the two approaches yield approximately similar the welfare cost of inflation for the log-log specification.

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Paper provided by University Library of Munich, Germany in its series MPRA Paper with number 47549.

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Date of creation: 15 Jan 2013
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Handle: RePEc:pra:mprapa:47549
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  1. Rana Ejaz Ali Khan & Qazi Muhammad Adnan Hye, 2013. "Financial liberalization and demand for money: a case of Pakistan," Journal of Developing Areas, Tennessee State University, College of Business, vol. 47(2), pages 175-198, July-Dece.
  2. Mohsin S. Khan & Axel Schimmelpfennig, 2006. "Inflation in Pakistan: Money or Wheat?," IMF Working Papers 06/60, International Monetary Fund.
  3. Cooley, Thomas F & Hansen, Gary D, 1991. "The Welfare Costs of Moderate Inflations," Journal of Money, Credit and Banking, Blackwell Publishing, vol. 23(3), pages 483-503, August.
  4. Abdul Qayyum, 2000. "Demand for Real Money Balances by the Business Sector: An Econometric Investigation," The Pakistan Development Review, Pakistan Institute of Development Economics, vol. 39(4), pages 857-873.
  5. Martha López, 2001. "Seigniorage And The Welfare Cost Of Inflation In Colombia," ENSAYOS SOBRE POLÍTICA ECONÓMICA, BANCO DE LA REPÚBLICA - ESPE.
  6. Gillman, Max, 1993. "The welfare cost of inflation in a cash-in-advance economy with costly credit," Journal of Monetary Economics, Elsevier, vol. 31(1), pages 97-115, February.
  7. Kiyotaki, Nobuhiro & Wright, Randall, 1989. "On Money as a Medium of Exchange," Journal of Political Economy, University of Chicago Press, vol. 97(4), pages 927-54, August.
  8. Abdul Qayyum, 2001. "Sectoral Analysis of the Demand for Real Money Balances in Pakistan," The Pakistan Development Review, Pakistan Institute of Development Economics, vol. 40(4), pages 953-966.
  9. Qayyum, Abdul, 1998. "Error Correction Model of the Demand for Money in Pakistan," MPRA Paper 2582, University Library of Munich, Germany, revised 1998.
  10. Abdul Qayyum, 2005. "Modelling the Demand for Money in Pakistan," The Pakistan Development Review, Pakistan Institute of Development Economics, vol. 44(3), pages 233-252.
  11. Bali, Turan G., 2000. "U.S. money demand and the welfare cost of inflation in a currency-deposit model," Journal of Economics and Business, Elsevier, vol. 52(3), pages 233-258.
  12. Abdul Qayyum, 2006. "Money, Inflation, and Growth in Pakistan," The Pakistan Development Review, Pakistan Institute of Development Economics, vol. 45(2), pages 203-212.
  13. Barro, Robert J., 1972. "Inflationary Finance and the Welfare Cost of Inflation," Scholarly Articles 3451393, Harvard University Department of Economics.
  14. Syed Muhammad Tariq & Kent Matthews, 1997. "The Demand for Simple-sum and Divisia Monetary Aggregates for Pakistan: A Cointegration Approach," The Pakistan Development Review, Pakistan Institute of Development Economics, vol. 36(3), pages 275-291.
  15. Mohsin S. Khan & Axel Schimmelpfennig, 2006. "Inflation in Pakistan," The Pakistan Development Review, Pakistan Institute of Development Economics, vol. 45(2), pages 185-202.
  16. Tower, Edward, 1971. "More on the Welfare Cost of Inflationary Finance," Journal of Money, Credit and Banking, Blackwell Publishing, vol. 3(4), pages 850-60, November.
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