The varying interest elasticity and the cost of inflation in India

Abstract

This article estimates the welfare cost of inflation in India using the time-varying interest semi-elasticity from the money demand schedule. The estimated interest semi-elasticity and the welfare cost of inflation for India show variation over time. The result suggests increasing welfare cost of inflation for Indian economy in recent times.

Keywords:

• inflation
• interest rate
• money
• monetary policy
• elasticity

JEL Classification:

• E31
• E41

Notes

¹ The welfare cost estimates in the current approach account for only the money demand distortion brought about by positive nominal interest rates. However, other marginal decisions can also get distorted by the inflation causing additional loss to the output. Nevertheless, these estimates will provide a lower bound.

² The fitted curves are used as a first check to see if the two functional forms make any big difference in the Indian data.