Welfare costs of inflation when interest-bearing deposits are disregarded: A calculation of the bias

Abstract

Most estimates of the welfare costs of in ation are devised considering only noninterest- bearing assets, ignoring that since the 80 s technological innovations and new regu- lations have increased the liquidity of interest-bearing deposits. We investigate the resulting bias. Su¢ cient and necessary conditions on its sign are presented, along with closed-form expressions for its magnitude. Two examples dealing with bidimen- sional bilogarithmic money demands show that disregarding interest-bearing monies may lead to a non-negligible overestimation of the welfare costs of in ation. An intu- itive explanation is that such assets may partially make up for the decreased demand of noninterest-bearing assets due to higher in ation.