The welfare cost of inflation in countries with negative short-term rates
In this paper Benati and Nicolini present new estimates of the welfare cost of inflation by computing the area under the real money demand curve. Their research is novel as it studies advanced economies with recent experience of very low, even negative, short-term rates. Other important aspects of the paper:
- For the US, they use a new real money demand aggregate by adding Money Market Demand Accounts, which were created in 1984, to M1. Regulatory changes in 1982-84 altered the availability of transactional assets in the U.S. rendering real money demand unstable. Their new money demand aggregate remedies this problem.
- They construct upper and lower bounds for the estimate of the welfare cost. The area under the money demand curve is an almost exact measure of the welfare cost for a very general class of monetary models in the neighborhood of zero.
We find that for the United States, the cost of a steady state nominal interest rate of 5% is between 0.20% and 1.50% of lifetime consumption, depending on the assumptions regarding the lower bound and the functional form. The costs for the United Kingdom, Canada, and Japan are within the same range. Estimates are larger for the euro area, Sweden, and Switzerland, where they can go as high as 2% of lifetime consumption.
The Welfare Costs of Inflation
Authors: Luca Benati, Juan Pablo Nicolini
From: University of Bern, Federal Reserve Bank of Minneapolis
The welfare cost of inflation with a different real money demand aggregate
Serletis et al. use the Divisia M4 monetary aggregate instead of M1 or the adjusted M1 used by Benati and Nicolini above. This new aggregate allows them to use a neoclassical demand theory which combines demand for money with the demand for consumption and leisure. The welfare cost of inflation is then defined as the change in the area under the inverse money demand curve corresponding to the change in the holdings of real money balances.
[R]aising the inflation rate from 2% to 4% in the United States, would impose (on average) a welfare cost equivalent to a loss of 0.30 percent of output when money is measured by our preferred (broad) Divisia M4 monetary aggregate.
The Welfare Cost of Inflation
Authors: Apostolos Serletis, Libo Xu
From: University of Calgary, University of San Francisco
