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’s (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.
