Rebalancing Frequency and the Welfare Cost of Inflation
American Economic Journal: Macroeconomics, 4(2): 153-183, 2012
Posted: 21 Aug 2013
Date Written: April 2012
Cash-in-advance models usually require agents to reallocate money and bonds in fixed periods. Every month or quarter, for example. I show that fixed periods underestimate the welfare cost of inflation. I use a model in which agents choose how often they exchange bonds for money. In the benchmark specification, the welfare cost of 10 percent instead of 0 inflation increases from 0.1 percent of income with fixed periods to 1 percent with optimal periods. The results are robust to different preferences, to different compositions of income in bonds or money, and to the introduction of capital and labor.
Keywords: portfolio rebalancing frequency, welfare cost of inflation, money demand, cash-in-advance models, market segmentation
JEL Classification: E30, E40, E50
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