Financial Innovation and the Transactions Demand for Cash

Fernando E. Alvarez and Francesco Lippi

No 13416, NBER Working Papers from National Bureau of Economic Research, Inc

Abstract: We document cash management patterns for households that are at odds with the predictions of deterministic inventory models that abstract from precautionary motives. We extend the Baumol-Tobin cash inventory model to a dynamic environment that allows for the possibility of withdrawing cash at random times at a low cost. This modification introduces a precautionary motive for holding cash and naturally captures developments in withdrawal technology, such as the increasing diffusion of bank branches and ATM terminals. We characterize the solution of the model and show that qualitatively it is able to reproduce the empirical patterns. Estimating the structural parameters we show that the model quantitatively 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.

JEL-codes: E31 E4 E41 (search for similar items in EconPapers)
New Economics Papers: this item is included in nep-cba, nep-dge, nep-mac and nep-mon
Date: 2007-09
Note: EFG ME
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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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