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WELFARE COST OF INFLATION IN A GENERAL EQUILIBRIUM MODEL WITH CURRENCY AND INTEREST-BEARING DEPOSITS

Published online by Cambridge University Press:  01 September 2004

BARRY JONES ,
GABRIEL ASAFTEI  and
LIAN WANG
BARRY JONES
Affiliation:
State University of New York at Binghamton
GABRIEL ASAFTEI
Affiliation:
State University of New York at Binghamton
LIAN WANG
Affiliation:
State University of New York at Binghamton
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Abstract

We generalize a money-in-the-utility function model to include interest-bearing deposits and use the model to estimate the welfare cost of inflation. In the model, the user cost of deposits is invariant to inflation in steady state. Currency and deposits are assumed to be weakly separable and the model is calibrated using index number methods. We find that the welfare cost of inflation is substantially lower in the model with interest-bearing deposits than in models where all monetary assets are assumed to be non-interest bearing. We also show that higher inflation can raise or lower the rate of convergence to steady state depending on the coefficient of relative risk aversion, but the effect is weak. We provide evidence for OECD countries suggesting that there could be a positive effect of inflation on user costs, which would lead to higher welfare cost estimates.

Keywords

Welfare CostInflationMoney DemandMonetary Aggregation Theory
Type
ARTICLES
Information
Macroeconomic Dynamics , Volume 8 , Issue 4 , September 2004 , pp. 493 - 517
Copyright
© 2004 Cambridge University Press

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