Working Paper: CEPR ID: DP1358
Authors: Casey B. Mulligan; Xavier X. Sala-i-Martin
Abstract: In this paper we argue that the relevant decision for the majority of US households is not the fraction of assets to be held in interest-bearing form, but whether to hold such assets at all (we call this ?the decision to adopt? financial technology). We show that the key variable governing the adoption decision is the product of the interest rate and the total amount of assets. The implication is that, instead of studying money demand using time series and looking at historical interest rate variations, we can look at a cross-section of households and analyse variations in the amount of assets held. We can use this methodology to estimate the interest elasticity of money demand at interest rates close to zero.We find that: (a) the elasticity of money demand is very small when the interest rate is small; (b) the probability that a household holds any amount of interest-bearing assets is positively related to the level of financial assets; and (c) the cost of adopting financial technologies is positively related to age and negatively related to the level of education. The finding that the elasticity is very small for interest rates below 5% suggests that the welfare costs of inflation are small. We also find that with interest rates at 6%, the elasticity is close to 0.5. We find that roughly one-half of this elasticity can be attributed to the Baumal-Tobin effect or intensive margin and the other half to the new adopters or extensive margin. The intensive margin is less important at lower interest rates and more important at higher interest rates.
Keywords: money demand; optimal inflation tax; adoption of financial technologies; welfare cost of inflation; monetary policy
JEL Codes: E40; E41; E44; E52
Edges that are evidenced by causal inference methods are in orange, and the rest are in light blue.
| Cause | Effect |
|---|---|
| interest rates (E43) | decision to adopt financial technology (O14) |
| total amount of assets (G32) | decision to adopt financial technology (O14) |
| level of financial assets (G19) | probability of adopting interest-bearing assets (E43) |
| age (J14) | probability of adopting interest-bearing assets (E43) |
| education (I29) | probability of adopting interest-bearing assets (E43) |
| interest rates (E43) | elasticity of money demand (E41) |
| Baumol-Tobin effect (E31) | elasticity of money demand (E41) |
| new adopters (D16) | elasticity of money demand (E41) |