Currency and Checking Deposits as Means of Payment” Review of Economic Dynamics 14

We consider a record keeping cost to distinguish checking deposits from currency in a model where means-of-payment decisions and liquidity of assets are modelled explicitly. An equilibrium exists where checks are used only in big transactions while cash is used in all transactions. We study the effects of monetary policy on the equilibrium portfolios, liquidity and the rate of return distribution of assets. Higher inßation or lower reserve requirements raise the deposit interest rate, lower the currency deposit ratio and thereby increase the money multiplier and money supply. However, both policies have differential impacts on the terms of trade in transactions using different means of payment. During high inßation, individuals economize on the holding of nominal assets and use checks more often, implying higher liquidity ofM1. This increase in liquidity is individuals optimal response to inßation