Demand for Liquidity and Welfare Cost of Inflation by Cohort and Age of Households

Yaz Terajima, José-Víctor Ríos-Rull, Césaire Meh and Shutao Cao
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Césaire Meh: Bank of Canada

No 569, 2013 Meeting Papers from Society for Economic Dynamics

Abstract: Cross-sectional data show that money holding differs significantly over household consumption and age. Liquidity demand for money (i.e., money holding per dollar of consumption) decreases as household consumption increases. It also increases with household age conditional on the level of consumption. Observed age differences in money holdings contain not only age-specific information but also cohort-specific one. Using a life-cycle model, this paper disentangles these two effects on money demand and quantifies welfare gains of reducing the long-run inflation rate. We dynamically calibrate the model to micro data and macroeconomic conditions over time. We find that, although a large part of the observed cross-sectional age differences in money demand can be accounted for by some age effects, cohort effects play a non-negligible part, supporting a presence of financial innovation. In addition, changing inflation has significantly different impacts across household groups due to their heterogeneity in money holding. When inflation increases from the 2009 level to 10%, we find the aggregate welfare loss in consumption to be 1.34%. These losses are accrued mostly by generations that are currently alive and less by future cohorts. Finally, poorer households lose more than their rich peers.

Date: 2013
New Economics Papers: this item is included in nep-cba, nep-dge, nep-mac and nep-mon
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