The Cost of Holding Money

The Cost of Holding Money


the nominal interest rate is the opportunity cost of holding money: it is what you give up by holding money rather than bonds.

The cost of holding money equals the nominal interest rate is by comparing the real returns on alternative assets. Assets other than

money, such as government bonds, earn the real return r. Money earns an expected real return of −Ep, because its real value declines at the rate of inflation.

When you hold money, you give up the difference between these two returns.

Thus, the cost of holding money is r − (−Ep), 

which the Fisher equation tells us is the nominal interest rate i.