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The Role of Price Level Uncertainty in Determining the Opportunity Cost of Holding Money

Jeremy J. Siegel

Rodney L. White Center for Financial Research Working Papers from Wharton School Rodney L. White Center for Financial Research

Abstract: This paper explores the role of uncertain price level movements in determining the opportunity cost of holding both fiat and commodity moneys. It is shown that a monetary medium whose opportunity cost fluctuates countercyclically to real asset values lowers interest rates for bonds denominated in that medium and hence lowers the cost to the economy of using that money. Empirical evidence in recent years indicates that fluctuations in gold have been decidedly countercyclical while those of U.S. fiat money have been procyclical. The paper also explains the role of uncertain inflation in generating a demand for nominally denominated contracts. Such demands may arise if capital markets are incomplete or non-diversifiable human wealth is a significant portion of an individual’s assets.

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