The welfare cost of inflation revisited: The role of financial innovation and household heterogeneity *

The money-consumption ratio increases with age and decreases with consumption, and the recent era of low interest rates has seen a large increase in the aggregate money consumption ratio. We estimate an overlapping generations model with money for transaction purposes for the age effects and the extent of financial innovation using aggregate and household-level money holdings. We then assess the welfare cost of a 3 percentage point increase in inflation, incorporating the cost from the redistribution of non-money nominal wealth. We find that the welfare costs are 13% of one-year consumption and are borne mostly by the poor and the old. Crown Copyright (c) 2020 Published by Elsevier B.V. All rights reserved.