Working Paper

Inflation and financial sector size

Abstract: Traditionally, the cost of expected inflation has been seen as the \"shoeleather cost\" of going to the bank more often. This paper focuses on the other side of these transactions--i.e., on the increased production of financial services by financial firms. I construct a model in which households must make purchases either with cash or with costly transactions services produced by firms in the financial services sector. Higher inflation leads households to substitute purchased transactions services for money balances, increasing the size of the financial sector. A test of the model using cross-sectional data suggests that this effect is large.

Keywords: Banks and banking - Customer services; Inflation (Finance);

Bibliographic Information

Provider: Board of Governors of the Federal Reserve System (U.S.)

Part of Series: Finance and Economics Discussion Series

Publication Date: 1996

Number: 96-16