Rebalancing Frequency and the Welfare Cost of Inflation

Abstract

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.JEL Codes: E3, E4, E5.

The effect of firm cash holdings on monetary policy

“…As explained in section 4, the cash-sales distribution for each year is obtained by determining the values of v Y i and N i so that the distribution of the cash-sales ratio from the model approximates the actual distribution of the cash-sales ratio given by Compustat data. 19 According to proposition 1, the real interest rate rr (t) implied by the shock to r (t) depends on the distribution of the cash-sales ratio 17 This value for has been used by Lucas (2000), Silva (2012), among others. It implies that a nominal interest rate of 3 percent per year in the steady state generates zero in ‡ation.…”

“…We modify the models in and Silva (2012) to match the observed distribution of …rm cash holdings in the data. show that the model closely matches the short-run ‡uctuations in velocity.…”

“…In Silva (2012), money is held for transactions and velocity is allowed to vary according with the opportunity cost of money. This can explain the upward trend in …rm cash holdings.…”

The Effect of Firm Cash Holdings on Monetary Policy

“…The entrepreneurs smooth their consumption using cash and non contingent bonds. Unlike bonds, cash pays no interest, but consump-11 In Silva (2012), money is held for transactions and velocity is allowed to vary according with the opportunity cost of money. This can explain the upward trend in …rm cash holdings.…”

“…We modify the models in Silva (2012) to match the observed distribution of …rm cash holdings in the data. show that the model closely matches the short-run ‡uctuations in velocity.…”