On the Instability of Long‐Run Money Demand and the Welfare Cost of Inflation in the United States

We evaluate the policy implications of measuring the welfare cost of inflation accounting for instabilities in the long-run money demand for the U.S. over the period 1900-2013. We extend the analysis and reassess the results reported in Lucas (2000) and Ireland (2009), also considering the recent theoretical contributions of Lucas and Nicolini (2015) and Berentsen et al. (2015). Breaks in the long-run money demand give rise to regime-dependent welfare cost estimates. We find that the welfare cost is about 0.1% of annual income over 1976-2013, as compared to 0.8% over 1945-1975. Overall, these values are substantially lower than those reported in the literature.