Abstract:
This paper, first, estimates the appropriate, log–log or semi-log, linear longrun
money-demand relationship capturing the behavior US money demand over the
period of 1980:Q1–2010:Q4, using the standard linear cointegration procedures found
in the literature, and the corresponding nonparametric version of the same based on
projection pursuit regression (PPR) methods. We then, compare the resulting welfare
costs of inflation obtained from the linear and nonlinear money-demand cointegrating
equations. We make the following observations: (i) the appropriate money-demand
relationship for the period of 1980:Q1–2010:Q4 is captured by a semi-log function;
(ii) based on the estimation of semi-log cointegrating equations, the welfare cost of
inflation was found to at the most lie between 0.0131 % of GDP and 0.2186 % of
GDP for inflation rates between 0 and 10 %, and; (iii) in comparison, the welfare
cost of inflation obtained from the semi-log non-linear long-run money-demand function,
derived using the PPR method, for 0–10 % of inflation ranges between 0.4930
and 1.9468 % of GDP. However, the standard errors associated with the welfare cost
estimates obtained from PPR relative to the linear models tend to indicate that the nonlinear
money demand provides more precise estimates of the welfare costs primarily
for higher rates of inflation.
