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Financial Innovations, Money Demand, and the Welfare Cost of Inflation
Author(s) -
BERENTSEN ALEKSANDER,
HUBER SAMUEL,
MARCHESIANI ALESSANDRO
Publication year - 2015
Publication title -
journal of money, credit and banking
Language(s) - English
Resource type - Journals
SCImago Journal Rank - 1.763
H-Index - 108
eISSN - 1538-4616
pISSN - 0022-2879
DOI - 10.1111/jmcb.12219
Subject(s) - economics , inflation (cosmology) , monetary economics , monetary policy , market liquidity , welfare , endogenous money , demand deposit , demand for money , interest rate , money market , construct (python library) , market economy , physics , theoretical physics , computer science , programming language
In the 1990s, the empirical relationship between money demand and interest rates began to fall apart. We analyze to what extent financial innovations can explain this breakdown. For this purpose, we construct a microfounded monetary model with a money market that provides insurance against liquidity shocks by offering short‐term loans and by paying interest on money market deposits. We calibrate the model to U.S. data and find that the introduction of the sweep technology at the beginning of the 1990s, which improved access to money markets, can explain the behavior of money demand very well. Furthermore, by allowing a more efficient allocation of money, the welfare cost of inflation decreased substantially.