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Working Paper 2009-019B

"Liquidity and Welfare in a Heterogeneous-Agent Economy"
by Yi Wen

This paper reconsiders the welfare costs of inflation and the welfare gains from financial intermediation in a heterogeneous-agent economy where money is held as a store of value (as in Bewley, 1980). Because of heterogeneous liquidity demand, transitory lump-sum money injections can have persistent expansionary effects despite flexible prices, and such effects can be greatly amplified by the banking system through the credit channel. However, permanent money growth can be extremely costly: With log utility functions, consumers are willing to reduce consumption by 15% (or more) to avoid a 10% annual inflation. For the same reason, financial intermediation can significantly improve welfare: The welfare costs of a collapse of the banking system is estimated as about 10-68% of aggregate output. These welfare implications differ dramatically from those of the existing literature.

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Category > Monetary Policy/Macroeconomics
Author > Yi Wen
Research Papers and Publications: JEL Code > E12
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Research Papers and Publications: JEL Code > E31
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