Shoe-leather and 'bricks-and-mortar' as inputs into transaction technology

Abstract

This thesis explains the difference between the long run and short run income and interest elasticities of money demand by the presence of a fixed input into the creation of transactions in a cash-in advance model of money demand. This structure implies a time element for the response of money demand to changes in income and interest. The implication of the fixed input into the consumer’s transactions technology causes the income elasticity of money demand to be more elastic in short run whereas the interest rate elasticity to be more elastic in the long run. Besides, the presence of a fixed input provides a micro foundation for price stickiness and a time dynamic welfare cost of inflation. Empirical evidence from the US over 1959:1 – 2006:4 period verifies the predictions of our theoretical model on elasticities. To demonstrate that the theoretical model explains observed price stickiness, we use the empirical model to derive a version of the P-Star model of sticky prices. The estimated parameters point out the higher relative productivity of fixed input than of variable input, and a considerably high welfare cost of inflation.