Working Paper

Optimal money demand in a heterogeneous-agent cash-in-advance economy

Abstract: Heterogeneity matters. This point is illustrated in a heterogeneous-agent, cash-in-advance economy where money serves both as a medium of exchange and as a store of value (as in Lucas, 1980). It is shown that heterogeneity can lead to dramatically different implications of monetary policies from those under the representative-agent assumption, including (i) the velocity of money is not constant but highly volatile, as in the data; (ii) lump-sum transitory money injections have expansionary effects on aggregate output despite flexible prices; and (iii) the welfare cost of anticipated inflation is potentially a couple of orders larger than the estimates of Cooley and Hansen (1989) based on a representative-agent, cash-in-advance economy.

Keywords: Demand for money; Monetary theory;

Bibliographic Information

Provider: Federal Reserve Bank of St. Louis

Part of Series: Working Papers

Publication Date: 2010

Number: 2010-014