Abstract

In this paper, using the Fisher and Seater (1993) long-horizon approach, the writers estimate the long-run equilibrium relationship between money balance as a ratio of income and the Treasury bill rate for South Africa over the period 1965:02 to 2007:01, and, in turn, use the obtained estimates of the interest elasticity and the semi-elasticity to derive the welfare cost estimates of inflation, using both Bailey’s (1956) consumer surplus approach and Lucas’ (2000) compensating variation approach. When the results are compared to welfare cost estimates obtained recently by Gupta and Uwilingiye (2008), using the same data set, but basing it on Johansen’s (1991, 1995) cointegration technique, the values are less than half of those obtained in the latter study. These range from 0.16 percent to 0.36 percent of GDP for the target-band of three percent to six percent of inflation. The paper thus highlights the fact that welfare cost estimates of inflation are sensitive to the methodology used to estimate the long-run equilibrium money demand relationships.

Highlights

  • In a recent study, Gupta and Uwilingiye (2008) measured the welfare cost of inflation in South Africa, based on estimates of the interest elasticity and semi-elasticity of money demand functions, which were obtained using the Johansen (1991, 1995) methodology on quarterly data for M3, GDP and the Treasury bill rate

  • Based on the results reported in columns 2 and 3, and 4 and 5, the welfare cost estimates obtained under the consumer surplus approach, for 3 percent, 6 percent, 10 percent and 15 percent of inflation, using the Johansen (1991 and 1995) cointegration method and the longhorizon regression approach respectively, we see that welfare costs are substantially lower in the latter case

  • When the results are compared with welfare cost estimates obtained recently by Gupta and Uwilingiye (2008), using the same data set, but based on Johansen’s (1991, 1995) cointegration technique, the values are less by more than half of those obtained in the latter study

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Summary

Introduction

In a recent study, Gupta and Uwilingiye (2008) measured the welfare cost of inflation in South Africa, based on estimates of the interest elasticity and semi-elasticity of money demand functions, which were obtained using the Johansen (1991, 1995) methodology on quarterly data for M3, GDP and the Treasury bill rate. Basing their study on the long-horizon regression approach proposed by Fisher and Seater (1993), the researchers Serletis and Yavari (2004), in their study dealing with the welfare cost of inflation for Canada and the United States, came up with much smaller figures than those of Lucas (2000), who had indicated that a reduction in the nominal rate from 0 percent to 3 percent would yield a benefit equivalent to 0.90 percent of real income.

The theoretical foundations
Empirical methodology and results
Findings
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