How Uncertain are the Welfare Costs of Inflation?

Bank of England Working Paper No. 152

42 Pages Posted: 25 Jun 2002

See all articles by Hasan Bakhshi

Hasan Bakhshi

Bank of England - Monetary Analysis

Benjamin Martin

Bank of England

Anthony Yates

Bank of England - Monetary Analysis

Date Written: February 2002

Abstract

This paper quantifies for the United Kingdom the general equilibrium costs of individuals holding cash to economise on 'shopping time'. These are a subset of a wider range of costs caused by inflation. The paper tests whether or not money balances tend to a finite number as nominal interest rates tend to zero, and investigates how sensitive to this test are the welfare implications of rates of inflation above the Friedman rule (a zero nominal interest rate). The paper then explores how uncertainties about the shape of the money demand curve translate into uncertainties about these welfare costs of inflation. A key uncertainty is the existence of a satiation point for money balances. Using Monte Carlo tests, it is shown that without observations at nominal interest rates very close to zero, the power of satiation tests can be very low. This finding may also be important for evaluating whether/how monetary policy could stabilise the economy in the event of a shock large enough to require that nominal interest rates are driven close to zero.

Suggested Citation

Bakhshi, Hasan and Martin, Benjamin and Yates, Anthony, How Uncertain are the Welfare Costs of Inflation? (February 2002). Bank of England Working Paper No. 152, Available at SSRN: https://ssrn.com/abstract=315100 or http://dx.doi.org/10.2139/ssrn.315100

Hasan Bakhshi (Contact Author)

Bank of England - Monetary Analysis ( email )

Threadneedle Street
London EC2R 8AH
United Kingdom
020 7601 5996 (Phone)

Benjamin Martin

Bank of England ( email )

Threadneedle Street
London, EC2R 8AH
United Kingdom

Anthony Yates

Bank of England - Monetary Analysis ( email )

Threadneedle Street
London EC2R 8AH
United Kingdom

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