The welfare cost of inflation in generalized general equilibrium models

The objective of my dissertation is to study the welfare cost of inflation in a general equilibrium framework that takes into account more realistic factors in the real world, a framework with more generalized model settings of money demand side and money supply side. On the money demand side, we introduced interest-bearing deposits applying the monetary aggregation theory; on the supply side, we established a banking sector that produces interest-bearing deposits. We found that the welfare cost of inflation is substantially low compared with the estimates in the model with only non-interest-bearing assets, and is much lower than that estimated by Lucas (2000).; We also investigated the role of required reserves and excess reserves. Required reserves are equivalent to the introduction of a tax wedge on the supply price of financial assets, and it is passed entirely to the household in general equilibrium. The prices of interest-bearing deposits are no longer invariant to changes in the rate of inflation. The welfare cost of inflation increases because interest-bearing deposits will be only partially shielded from the costs of inflation. People tend to substitute toward the monetary assets subject to lower reserve requirements. Excess reserve is treated as an input to the production technology of the banking sector. The user cost of excess reserves is the nominal interest rate. An increase in the rate of inflation will cause substitution away from excess reserves to the other inputs, labor and capital. The increase in the demand for labor and capital will then reduce the labor and capital inputs in the goods production, therefore reducing output available for consumption. This effect increases the welfare cost of inflation.; Since the welfare cost of inflation depends on the degree to which user costs of interest-bearing deposits vary with the rate of inflation, we conducted a research on the empirical relationship between the nominal interest rates and inflation. Using a cross-country sample, we found the empirical support to the non-linear relationship between inflation and interest rates. A new two-threshold specification has been developed to ensure that the estimated values are continues at the thresholds. Bootstrap approach has been used to estimate the thresholds in order to get more accurate estimations. For OECD countries, who are developed countries, there is only one threshold level of inflation below which inflation have stronger positive effect on interest rates than that above this level, and the effect of inflation on the user cost of deposit is even negative when the rate of inflation is above the threshold. When investigating the sample including OECD and all other countries, two threshold levels of inflation were found. Inflation has negative effect on the deposit and lending interest rates when it is below the lower threshold, and positive effect when it is above the lower threshold. (Abstract shortened by UMI.)...