Can Robbery and Other Theft Help Explain the Textbook Currency-Demand Puzzle? Two Dreadful Models of Money Demand with an Endogenous Probability of Crime
Levy Economics Institute Working Papers No. 529
29 Pages Posted: 12 Mar 2008 Last revised: 23 May 2008
Date Written: March 6, 2008
Abstract
This paper attempts to explain one version of an empirical puzzle noted by Mankiw (2003): a Baumol-Tobin inventory-theoretic money demand equation predicts that the average U.S. adult should have held approximately $551.05 in currency and coin in 1995, while data show an average of $100. The models in this paper help explain this discrepancy using two assumptions: (1) the probabilities of being robbed or pickpocketed, or having a purse snatched, depend on the amount of cash held; and (2) there are costs of being robbed other than loss of cash, such as injury, medical bills, lost time at work, and trauma. Two models are presented: a dynamic, stochastic model with both instantaneous and decaying noncash costs of robbery, and a revised version of the inventory-theoretic model that includes one-period noncash costs. The former model yields an easily interpreted first-order condition for money demand involving various marginal costs and benefits of holding cash. The latter model gives quantitative solutions for money demand that come much closer to matching the 1995 data - $75.98 for one plausible set of parameters. This figure implies that consumers held approximately $96 billion less cash in May 1995 than they would have in a world without crime. The modified Baumol-Tobin model predicts a large increase in household money demand in 2005, mostly due to reduced crime rates.
Keywords: Currency Demand; Crime; Baumol-Tobin; Dynamic Programming
JEL Classification: E410, D110, D900
Suggested Citation: Suggested Citation
Do you have a job opening that you would like to promote on SSRN?
Recommended Papers
-
Willingness-to-Pay for Crime Control Programs
By Mark A. Cohen, Roland T. Rust, ...
-
If Drug Treatment Works so Well, Why are so Many Drug Users in Prison?
By Harold A. Pollack, Peter H. Reuter, ...
-
Preferences for Social Inclusion: Empirical Evidence from Juvenile Rehabilitation in Italy
By Martina Menon, Federico Perali, ...