Financial Innovation and the Transactions Demand for Cash

Fernando Alvarez and Francesco Lippi

No 6472, CEPR Discussion Papers from C.E.P.R. Discussion Papers

Abstract: We extend the Baumol-Tobin cash inventory model to a dynamic environment, which allows for the possibility of withdrawing cash at random times at a low cost. This modification captures developments in withdrawal technology, such as the increasing diffusion of bank branches and ATM terminals. We document cash management patterns for households that are at odds with the predictions of deterministic inventory models that abstract from precautionary motives. We characterize the solution of the model and show that qualitatively it is able to reproduce such patterns. Estimating the structural parameters we show that the model accounts for key features of the data. The estimates are used to quantify the expenditure and interest rate elasticity of money demand, the impact of financial innovation on money demand, the welfare cost of inflation, the gains of disinflation and the benefit of ATM ownership.

Keywords: inventory models; money demand; technological progress (search for similar items in EconPapers)
JEL-codes: E5 (search for similar items in EconPapers)
New Economics Papers: this item is included in nep-cba, nep-dge, nep-ino and nep-mac
Date: 2007-09
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Related works:
Working Paper: Financial Innovation and the Transactions Demand for Cash (2007)
Journal Article: Financial Innovation and the Transactions Demand for Cash (2009)
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