Liquidity reallocation and the welfare cost of inflation in Colombia

Cristian Frasser and Juan Camilo Pájaro-Gallego ()
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Juan Camilo Pájaro-Gallego: Universidad del Valle

Lecturas de Economía, 2023, issue 98, 67-95

Abstract: This article evaluates the role of liquidity reallocation via credit in mitigating the welfare cost of inflation. It presents two theoretical models: with and without liquidity reallocation. In the model with liquidity reallocation, money and credit coexist. In particular, money exhibits a double benefit: it can be used to finance consumption or to lend it to agents with liquidity needs. The latter use of money balances through credit serves to cushion the welfare cost of inflation. Both models are calibrated for the Colombian economy between 1994 and 2021, which allows us to measure the impact of inflation on welfare in terms of GDP. The welfare cost of reducing inflation by 10 percentage points without reallocating liquidity, under the Nash protocol and with bargaining power less than 1, ranges between 2.6% and 4.2% of GDP, while with liquidity reallocation it is between 0.9% and 3.6% of GDP. The welfare cost associated with positive inflation is always lower with liquidity reallocation.

Keywords: inflation; welfare; money; credit; liquidity reallocation (search for similar items in EconPapers)
JEL-codes: E31 E40 E41 E51 (search for similar items in EconPapers)
Date: 2023
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DOI: 10.17533/udea.le.n98a348684

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