Cash, Checkable Deposits and Cost of Inflation
34 Pages Posted: 22 Jan 2015 Last revised: 5 Dec 2017
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Cash, Checkable Deposits and Cost of Inflation
Cash, Checkable Deposits and Cost of Inflation
Date Written: March 9, 2013
Abstract
The Welfare cost of inflation is revisited with a search-theoretic model wherein distinct features of cash and checkable deposits as means of payment are incorporated. Our result implies that the presence of an interest-bearing checkable deposit amplifies the cost of inflation significantly via a channel of option value of money.
Put differently, the cost of inflation is substantially underestimated under the assumption of non-interest-bearing M1. This is in stark contrast to the previous studies in which the assumption of non-interest-bearing M1 leads to a considerable overvaluation of an inflation cost. This finding provides the rationale for a low inflation target by the central bank where the payment system is highly developed.
Keywords: cash, interest-bearing checkable deposit, cost of inflation
JEL Classification: E31, E41, E51
Suggested Citation: Suggested Citation