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A TIME-VARYING APPROACH OF THE US WELFARE COST OF INFLATION

Published online by Cambridge University Press:  09 June 2017

Stephen M. Miller ,
Luis Filipe Martins  and
Rangan Gupta
Stephen M. Miller*
Affiliation:
University of Nevada, Las Vegas
Luis Filipe Martins
Affiliation:
ISCTE-IUL Business School
Rangan Gupta
Affiliation:
University of Pretoria
*
Address correspondence to: Stephen M. Miller, Department of Economics, University of Nevada, Las Vegas, Las Vegas, Nevada, 89154-6005, USA; e-mail: stephen.miller@unlv.edu.
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Abstract

Money-demand specifications exhibit instability, especially for long spans of data. This paper reconsiders the welfare cost of inflation for the US economy using a flexible time-varying (TV) cointegration methodology to estimate the money-demand function. We find evidence that the TV cointegration estimation provides a better fit of the actual data than a time-invariant estimation and that the throughout unitary income elasticity only exists for the log–log form over the entire sample period. Our estimate of the welfare cost of inflation for a 10% inflation rate lies in the range of 0.025–0.75% of gross domestic product (GDP) and averages 0.27%. In sum, our findings fall well within the ranges of existing studies of the welfare cost of inflation. We find that the welfare cost averages 7.4% higher during expansions than recessions for 10% inflation rate. Finally, the interest elasticity of money demand shows substantial variability over our sample period.

Keywords

Money-Demand FunctionWelfare Cost of InflationTime-Varying Cointegration
Type
Articles
Information
Macroeconomic Dynamics , Volume 23 , Issue 2 , March 2019 , pp. 775 - 797
Copyright
Copyright © Cambridge University Press 2017 

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