Rebalancing Frequency and the Welfare Cost of Inflation
American Economic Journal: Macroeconomics, 2012, 4(2): 153-183
FEUNL Working Paper Series No. 587
50 Pages Posted: 6 Jul 2014
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 ten percent instead of zero inflation increases from 0.1 percent of income with fixed periods to one 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: E3, E4, E5
Suggested Citation: Suggested Citation