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Finance and Economics Discussion Series
The Finance and Economics Discussion Series logo links to FEDS home page Inflation and Financial Sector Size
William B. English

Abstract: Traditionally, the cost of expected inflation has been seen as the "shoeleather cost" of going to the bank more often. This paper focuses on the other side of these transactions--i.e., on the increased production of financial services by financial firms. I construct a model in which households must make purchases either with cash or with costly transactions services produced by firms in the financial services sector. Higher inflation leads households to substitute purchased transactions services for money balances, increasing the size of the financial sector. A test of the model using cross-sectional data suggests that this effect is large.

Keywords: Inflation, transactions services, financial sector, money demand

Full paper (3423 KB PDF)

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Last update: July 16, 1997