Composition of portfolio and cost of inflation

Manjong Lee, Sung Guan Yun

Research output: Contribution to journalArticle

Abstract

The welfare cost of inflation is explored via a search-theoretic model in which along with non-interest-bearing cash, interest-bearing liquid and illiquid assets are available. With inflation, agents are willing to replace higher-return illiquid assets with lower-return liquid assets for consumption purchases. The opportunity cost incurred by this adjustment turns out to have quantitatively significant implications on the cost of inflation. A parameterized version of the model suggests that the cost of 10% inflation with liquid and illiquid interest-bearing assets is almost 3 times larger than that in a cash-only model. This implies that most existing measures of inflation cost with narrow money are substantially underestimated.

Original languageEnglish
Pages (from-to)1-21
Number of pages21
JournalJournal of Economic Theory and Econometrics
Volume25
Issue number4
Publication statusPublished - 2014 Jan 1

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ASJC Scopus subject areas

  • Economics and Econometrics

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