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Demand for Liquidity and Welfare Cost of Inflation by Cohort and Age of Households

Listed author(s):
  • Yaz Terajima

    (Bank of Canada)

  • Jose-Victor Rios-Rull

    (University of Minnesota)

  • Césaire Meh

    (Bank of Canada)

  • Shutao Cao

    (Bank of Canada)

Cross-sectional data show that money holding differs significantly over household consumption and age. Liquidity demand for money (i.e., money holding per dollar of consumption) decreases as household consumption increases. It also increases with household age conditional on the level of consumption. Observed age differences in money holdings contain not only age-specific information but also cohort-specific one. Using a life-cycle model, this paper disentangles these two effects on money demand and quantifies welfare gains of reducing the long-run inflation rate. We dynamically calibrate the model to micro data and macroeconomic conditions over time. We find that, although a large part of the observed cross-sectional age differences in money demand can be accounted for by some age effects, cohort effects play a non-negligible part, supporting a presence of financial innovation. In addition, changing inflation has significantly different impacts across household groups due to their heterogeneity in money holding. When inflation increases from the 2009 level to 10%, we find the aggregate welfare loss in consumption to be 1.34%. These losses are accrued mostly by generations that are currently alive and less by future cohorts. Finally, poorer households lose more than their rich peers.

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File URL: https://economicdynamics.org/meetpapers/2013/paper_569.pdf
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Paper provided by Society for Economic Dynamics in its series 2013 Meeting Papers with number 569.

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Date of creation: 2013
Handle: RePEc:red:sed013:569
Contact details of provider: Postal:
Society for Economic Dynamics Marina Azzimonti Department of Economics Stonybrook University 10 Nicolls Road Stonybrook NY 11790 USA

Web page: http://www.EconomicDynamics.org/
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  1. 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.
  2. Heer, Burkhard & Maußner, Alfred, 2012. "The Burden Of Unanticipated Inflation: Analysis Of An Overlapping-Generations Model With Progressive Income Taxation And Staggered Prices," Macroeconomic Dynamics, Cambridge University Press, vol. 16(02), pages 278-308, April.
  3. Chiu, Jonathan & Molico, Miguel, 2010. "Liquidity, redistribution, and the welfare cost of inflation," Journal of Monetary Economics, Elsevier, vol. 57(4), pages 428-438, May.
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