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Welfare costs of inflation when interest-bearing deposits are disregarded: A calculation of the bias

Authors
Journal
Journal of Economic Dynamics and Control
0165-1889
Publisher
Elsevier
Publication Date
Volume
34
Issue
6
Identifiers
DOI: 10.1016/j.jedc.2010.01.003
Keywords
  • Welfare
  • Inflation
  • Money Demand
  • Divisia Index
  • Interest-Bearing Monies

Abstract

Abstract Most estimates of the welfare costs of inflation are devised considering only noninterest-bearing assets, ignoring that since the 1980s technological innovations and new regulations have increased the liquidity of interest-bearing deposits. We investigate the resulting bias. Sufficient and necessary conditions on its sign are presented, along with closed-form expressions for its magnitude. Two examples dealing with bidimensional bilogarithmic money demands show that disregarding interest-bearing monies may lead to a non-negligible overestimation of the welfare costs of inflation. An intuitive explanation is that such assets may partially make up for the decreased demand of noninterest-bearing assets due to higher inflation.

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