Deposit spreads and the welfare cost of inflation

High nominal interest rates are associated with high deposit spreads, which is consistent with a model where banks have monopoly power and currency and deposits are substitutes. Therefore, higher interest rates raise the implicit price of banking services, increase bank profits and attract entry into the banking sector. Taking these effects into account, a one percentage point increase in inflation has a welfare cost of 0.083% of GDP, 6.7 times higher than traditional estimates.