Reconsidering the welfare cost of inflation in the US: a nonparametric estimation of the nonlinear long-run money-demand equation using projection pursuit regressions

This paper, first, estimates the appropriate, log–log or semi-log, linear long-run money-demand relationship capturing the behavior US money demand over the period of 1980:Q1–2010:Q4, using the standard linear cointegration procedures found in the literature, and the corresponding nonparametric version of the same based on projection pursuit regression (PPR) methods. We then, compare the resulting welfare costs of inflation obtained from the linear and nonlinear money-demand cointegrating equations. We make the following observations: (i) the appropriate money-demand relationship for the period of 1980:Q1–2010:Q4 is captured by a semi-log function; (ii) based on the estimation of semi-log cointegrating equations, the welfare cost of inflation was found to at the most lie between 0.0131 % of GDP and 0.2186 % of GDP for inflation rates between 0 and 10 %, and; (iii) in comparison, the welfare cost of inflation obtained from the semi-log non-linear long-run money-demand function, derived using the PPR method, for 0–10 % of inflation ranges between 0.4930 and 1.9468 % of GDP. However, the standard errors associated with the welfare cost estimates obtained from PPR relative to the linear models tend to indicate that the nonlinear money demand provides more precise estimates of the welfare costs primarily for higher rates of inflation.     

Currency substitution and seignorage in eastern europe

Economic and political uncertainty, high inflation and liberalization of foreign exchange restrictions have encouraged substantial currency substitution in the economies in transition. This paper presents empirical evidence on currency substitution in four Eastern European countries in transition: Poland, Hungary, Romania and Bulgaria. It is shown how currency substitution affects money demand and by that seignorage revenues. The empirical estimates of the money demand functions are used to calculate the seignorage maximizing rate of inflation in the economies in transition.     

WELFARE COST OF INFALTION IN A NEW KEYNESIAN MODEL

We study the welfare cost of inflation in a new Keynesian dynamic stochastic general equilibrium model. Nominal prices and wages are subjected to Taylor‐style adjustments in the benchmark model. We find that the welfare cost of inflation in a new Keynesian dynamic stochastic general equilibrium model is much higher than its counterpart in a real business cycle model. We also find that the welfare cost of inflation increases linearly with the inflation rate with the introduction of monopolistic competition but rises faster as the inflation rate increases with the introduction of nominal rigidity. Alternative price and wage setting schemes, such as Rotemberg and Calvo‐style adjustments would yield welfare costs of moderate inflation that are 2–10 times higher.     

Expectation traps in a new Keynesian open economy model

This paper illustrates that the presence of a money demand distortion in an otherwise standard new Keynesian open economy model results in multiple discretionary equilibria that arise in the form of expectations traps. If private sector inflation expectations become sufficiently unanchored, the model predicts that a monetary authority can easily be trapped into validating these expectations, thereby pushing the economy to a lower welfare equilibrium. Given the ease with which expectation traps arise in the presence of international linkages, the main result presented here suggests that maintaining well-anchored inflation expectations is a critically important policy goal for central banks in open economies.     

通货膨胀、政府收益与社会福利损失

传统"Cagan规则"认为,政府通货膨胀税收益最大化的条件是,通货膨胀率应该为(货币需求关于)利率半弹性的倒数。这一规则是局部均衡条件下的结果,并未考虑通胀的实际经济效应。本文基于交易成本方法在一般均衡框架内讨论收益最大化时通货膨胀率的决定问题。该框架中收益最大化的通货膨胀率小于Ca-gan规则值,这一结论得到了中国1945—1949年恶性通胀时期经验数据的支持。经验结果还表明,相对于Cagan规则,根据交易成本方法设定的通货膨胀率尽管并没有明显提高政府的通货膨胀税收益,却大幅降低了社会福利损失。     

Search, money, and inflation under private information

I study monetary exchange and inflation when buyers have private information about their willingness to pay for certain goods. Introducing imperfect information in the Lagos-Wright [A unified framework for monetary theory and policy analysis, J. Polit. Economy 113(3) (2005) 463-484] economy shows that the existence of monetary equilibrium is a more robust feature of the environment. In general, my model has a monetary steady state in which only a proportion of the agents hold money. Agents who do not hold money cannot participate in trade in the decentralized market. The proportion of agents holding money is endogenous and depends (negatively) on the level of expected inflation. As in Lagos and Wright's model, in equilibrium there is a positive welfare cost of expected inflation, but the origins of this cost are very different.     

Welfare cost of inflation in a stochastic balanced growth model

There is a large and growing literature on the welfare cost of inflation. However, work in this area tend to find moderate estimates of welfare gains. In this paper we reexamine welfare costs of inflation within a stochastic general equilibrium balanced growth model paying a particular attention to recursive utility, portfolio balance effects, and monetary volatility and monetary policy uncertainty. Our numerical analysis shows that a monetary policy that brings down inflation to the optimum level can have substantial welfare effects. Portfolio adjustment effects seem to be the dominant factor behind the welfare gains.     

A long-run,short-run,and politico-economic analysis of the welfare costs of inflation

The long-run, short-run, and politico-economic welfare implications of inflation are assessed in a Bewley model of money demand. All agents produce and consume every period, and hold money to self-insure against idiosyncratic risk. The model is calibrated so the equilibrium monetary distribution shares features with US data. The long-run welfare costs of inflation are shown to be large because inflation reduces the ability of money to mitigate risk. However, the beneficial redistributive effect of inflation is magnified along the short-run transition and reduces the overall costs. These short-run benefits result in a majority-rule inflation rate above the Friedman Rule.     

Money,liquidity and welfare

This paper develops an analytically tractable Bewley model of money demand to shed light on some important questions in monetary theory, such as the welfare cost of inflation. It is shown that when money is a vital form of liquidity to meet uncertain consumption needs, the welfare costs of inflation can be extremely large. With log utility and parameter values that best match both the aggregate money demand curve suggested by Lucas (2000) and the variance of household consumption, agents in our model are willing to reduce consumption by 3–4% to avoid 10% annual inflation. The astonishingly large welfare costs of inflation arise because inflation increases consumption risk by eroding the buffer-stock-insurance value of money, thus hindering consumption smoothing at the household level. Such an inflation-induced increase in consumption risk at the micro level cannot be captured by representative-agent models or the Bailey triangle. Although the development of financial intermediation can mitigate the problem, with realistic credit limits the welfare loss of moderate inflation still remains several times larger than estimations based on the Bailey triangle. Our findings provide a strong justification for adopting a low inflation target by central banks, especially in developing countries where money is the major form of household financial wealth.     

State-dependent pricing, inflation, and welfare in search economies

We investigate the welfare effects of inflation in economies with search frictions and menu costs. We first analyze an economy where there is no transaction demand for money balances: Money is a mere unit of account. We determine a condition under which strictly positive inflation is desirable. We relate this condition to a standard efficiency condition for search economies. Second, we consider a related economy in which there is a transaction role for money. In the absence of menu costs, the Friedman rule is optimal. In the presence of menu costs, the optimal inflation rate is negative for our numerical examples provided menu costs are small. A deviation from the Friedman rule can be optimal depending on the extent of the search externalities.     

Collaterals and macroeconomic volatility

In this paper, we study the effects of collaterals on business cycles and growth in monetary economies with credit market imperfections. We consider an endogenous growth model with a partial cash-in-advance constraint. It is assumed that the share of consumption purchases paid on credit depends positively on the collaterals available to the agent. In this case, money is no longer superneutral. We find that, under mild inflation rates, a higher money growth rate is welfare-improving and, surprisingly, it makes the occurrence of expectations-driven fluctuations less likely. The shape of credit share in consumption purchases, as outcome of regulatory policies, has an impact on both welfare and stability. In particular, the higher the sensitivity of the credit share to collaterals, the more stable the economy under rational expectations. These analytical findings are complemented by economic interpretations.     

Long-Run Links among Money, Prices and Output: Worldwide Evidence

Abstract. Starting from the quantity theory of money we analyse the dynamic relationships between money, real output and prices for an unbalanced panel of 110 economies. Complementary to trivariate analyses we also adopt a P-star model explaining inflation via an equilibrium price level (P-star), which in turn depends on potential output and money. A key issue of the paper is the cross-sectional stability of estimation and inference results. We find cointegration among the considered variables. Particularly for high inflation countries homogeneity between prices and money cannot be rejected. Given homogeneity we find evidence for an error-correction mechanism linking current price changes and the lagged price gap. Parameter estimates indicating the adjustment towards the price equilibrium are larger in absolute value for high inflation countries. The latter results indicate that central banks, even in high inflation countries, can improve price stability by controlling monetary growth.     

Money Demand in an EU Accession Country: A VECM Study of Croatia

The paper estimates the money demand in Croatia using monthly data from 1994 to 2002. A failure of the Fisher equation is found, and adjustment to the standard money‐demand function is made to include the inflation rate as well as the nominal interest rate. In a two‐equation cointegrated system, a stable money demand shows rapid convergence back to equilibrium after shocks. This function performs better than an alternative using the exchange rate instead of the inflation rate as in the ‘pass‐through’ literature on exchange rates. The results provide a basis for inflation rate forecasting and suggest the ability to use inflation targeting goals in transition countries during the EU accession process. Finding a stable money demand also limits the scope for central bank ‘inflation bias’.     

Foreign output shock in small open economies: A welfare evaluation of monetary policy regimes

We examine the impact of negative foreign output shocks, which entail negative demand side effects by lowering exports and positive supply side effects by lowering oil prices, on the welfare of non-oil producing, small open economies under five exchange rate and monetary policy regimes. We use a dynamic stochastic general equilibrium model with parameter values calibrated for Hong Kong, Israel, Singapore, South Korea and Taiwan. We find that welfare levels among the five policy regimes depend on the economy's share of oil imports in world oil consumption. Hong Kong, Singapore and Israel, which have smaller shares, maximize welfare under the Taylor rule, which targets both CPI inflation and real output. South Korea, with higher shares, and Taiwan, with more rigid prices, maximize welfare under real output targeting. CPI inflation targeting, nominal output growth targeting and fixed exchange rate regimes generate lower welfare. However, optimal monetary policy, which generates the highest welfare, gives greater weight on real output than CPI inflation.     

中国通货膨胀的福利成本研究

通货膨胀一直以来都是衡量一国宏观经济运行是否稳定和健康的重要指标。本文对国内外关于通货膨胀福利成本的研究发展进行了较为完整的综述,并在此基础之上运用消费者剩余方法和新古典宏观经济学一般均衡模型对中国通货膨胀的福利成本进行了计算和比较。实证结果说明,在中国高通货膨胀会带来较高的福利损失,因此将通胀率保持在较低的水平对提高中国的经济福利水平是有利的。     

Time-varying money demand and real balance effects

This paper presents an analysis of the stimulants and consequences of money demand dynamics. By assuming that household's money holdings and consumption preferences are not separable, we demonstrate that the interest-elasticity of demand for money is a function of the household's preference to hold real balances, the extent to which these preferences are not separable in consumption and real balances, and trend inflation. An empirical study of U.S. data revealed that there was a gradual fall in the interest elasticity of money demand of approximately one-third during the 1970s due to high trend inflation. A further decline in the interest-elasticity of the demand for money was observed in the 1980s due to the changing household preferences that emerged in response to financial innovation. These developments led to a reduction in the welfare cost of inflation that subsequently explains the rise in monetary neutrality observed in the data.     

SCALE ECONOMIES AND HETEROGENEITY IN BUSINESS MONEY DEMAND: THE ITALIAN EXPERIENCE

This paper investigates the demand for money by firms and the existence of economies of scale in the Italian manufacturing industry. We estimate a model for cash elaborated by Fujiki and Mulligan using a different estimation procedure from the previous literature. We then introduce an iterative procedure based on backward exclusion of firms from model estimation which points out the high heterogeneity of Italian companies in money demand. Our estimates show that the Italian manufacturing industry, considered as a whole, does not enjoy scale economies in money demand. However, our iterative procedure points out that the cause of this result has to be ascribed to small firms which are characterized by thin cash money holdings and a consequent very modest opportunity cost.     

Competing wage claims,cost inflation,and capacity utilization

This paper develops a theory of competing wage claims and cost inflation, and attempts to integrate this theory into the core of modern macroeconomic analysis. Specifically, the paper proposes an explanation for wage inertia and wage interdependence based on an application of duopoly theory to labor unions, and incorporates this microeconomic theory of labor union behavior into a macroeconomic general equilibrium model with goods, money, and bonds as well as two kinds of labor. Special emphasis is placed on the interplay between demand and cost factors in the inflation process and on the implications of wage competition among labor unions for the relationship between inflation and unemployment in the short and long run.     

How justified is abandoning money in the conduct of monetary policy in Australia on the grounds of instability in the money‐demand function?

The role of money in the design and conduct of monetary policy has reemerged as an important issue in both advanced and developing economies, especially since the 2007 global financial crisis. A growing body of recent literature suggests that the causal relationship between money supply growth and inflation remains intact across countries and over time and that this relation is not conditional on the stability of the money‐demand function or whether money is endogenous or exogenous. Moreover, critical for a rule‐based monetary policy is the presence of a long‐run stable money‐demand function, rather than a short‐run money‐demand model that may exhibit instability for many reasons, including problems with estimating a money‐demand model with high‐frequency data. Provided that a stable money‐demand function exists, it could be useful to establish long‐run equilibrium relations among money, output, prices, and exchange rates, as the classical monetary theory suggests. Within this analytical framework, this paper addresses the question of whether money has any role in the conduct of monetary policy in Australia. The conventional wisdom is that the money‐demand function in Australia has been unstable since the mid‐1980s due to financial deregulation and reforms; this led to a change in the strategy of monetary policy for price stability in the form of inflation targeting that ignores money insofar as inflation and its control are concerned. This paper reports empirical findings for Australia, obtained from a longer quarterly data series over the period 1960Q1–2015Q1, which suggest that instability in the narrow‐money‐demand function in Australia was primarily due to the exclusion of variables which have become important in the deregulated environment since the 1980s. These findings are confirmed by an expanded form of the narrow‐money‐demand function that was found stable over the past two decades, although it experienced multiple structural breaks over the study period. The paper draws the conclusion that abandoning the monetary aggregate as an instrument of monetary policy in Australia, under a rule‐based monetary policy such as inflation targeting, cannot be justified by instability in the money‐demand function or even by lack of a causal link between money supply growth and inflation.     

Consumer preferences,the demand for Divisia money,and the welfare costs of inflation

This paper uses neoclassical demand theory to calculate the welfare costs of inflation. It considers the demand interactions between money, consumption goods, and leisure, relaxes the assumption of fixed consumer preferences, and addresses the inter-related problems of estimation of money demand functions, instability of money demand relations, and monetary aggregation. It makes full use of the relevant economic theory and econometrics and generates inference in terms of long-run welfare costs of inflation that is internally consistent with the data and models used.