WEALTH,ASSET PORTFOLIO,MONEY DEMAND AND POLICY RULE

I look at the linkages between monetary policy and asset wealth using quarterly data for the USA. I show that a positive interest rate shock leads to a fall in aggregate wealth and an important change in portfolio composition: housing wealth gradually decreases, but the effects are very persistent; and financial wealth quickly shrinks, but the impact is short‐lived. I also find that the money market can be characterized as follows: (i) the money demand has a large interest elasticity and a small output elasticity; and (ii) the estimated monetary policy reaction function highlights the special focus given by the central bank to developments in monetary aggregates. These features call for an approach whereby monetary authorities put more emphasis on tracking wealth developments, in particular, given the asset portfolio rebalancing between money holdings and financial and/or housing assets.     

Measuring income elasticity for Swiss money demand: What do the cantons say about financial innovation?

Recent time-series evidence has re-confirmed the forecasting ability of Swiss broad money. The same money demand studies and others, however, find that the income elasticity is greater than one. Such parameter estimates are difficult to reconcile with transactions demand theory. This study re-examines the estimates for income elasticity in money demand based on cross-regional evidence for Switzerland. Particular attention is given to the influence of regional financial sophistication. The cross-cantonal results find that the income elasticity lies between 0.4 and 0.6. This discrepancy between the two empirical methodologies has important consequences for the conduct of Swiss monetary policy.     

Demand for money in Bangladesh: a cointegration analysis

The aim of this study is to estimate the demand for real broad (M2) money in Bangladesh using the most recently developed autoregressive distributed lag approach to cointegration analyses. The empirical results show that there is a unique cointegrated and stable long-run relationship among real per capita broad money demand, real per capita income, domestic interest rates and unofficial exchange rate (UM) premiums which act as a surrogate for foreign interest rates. With money as the dependent variable, the results show that the income and interest elasticities are positive while the UM premium elasticity is negative. These results suggest that distortions in the financial and foreign exchange markets should be reduced in order to increase financial saving or monetary accumulation. Our results also reveal that the demand for money in Bangladesh is stable despite the changes in financial and exchange rate policies between 1975 and 1995.     

Money velocity and asset prices in the euro area

Monetary growth in the euro area has exceeded its target since several years. At the same time, the money demand function seems to be increasingly unstable if more recent data are used. If the link between money balances and the macroeconomy is fragile, the rationale of monetary aggregates in the ECB strategy has to be doubted. In fact, a rise in the income elasticity after 2001 can be observed, and may reflect the exclusion of real and financial wealth in conventional specifications of money demand. This presumption is explored by means of a cointegration analysis. To separate income from wealth effects, the specification in terms of money velocity is preferred. Evidence for the presence of wealth in the long run relationship is provided. In particular, both stock and house prices have exerted a negative impact on velocity after 2001 and lead to almost identical equilibrium errors. The extended error correction model is stable over the entire sample period and survive a battery of specification tests.

Substitution Between Money and Near-Monies in Switzerland

This paper investigates the substitutability between money and near-money assets during the period 1976 to 1996 in Switzerland. Financial developments have made a variety of instruments available to store wealth and conduct economic transactions. These developments have generated a “near money” component in households’ and businesses’ portfolio balances. It is important to evaluate the effect of “near-money” on money demand and the effectiveness of monetary policy. Towards this goal, five monetary assets: currency and demand deposits at commercial banks, demand deposits with the postal system, deposits on transaction accounts with banks, savings deposits and time deposits are considered. We evaluate the degree of substitutability among these assets using the Morishima elasticity. Results show that various monetary assets substitute for one another. Consistent with a high degree of diversification, the Morishima elasticity is significantly larger when adjustment takes place in the price of a relatively broader monetary asset as compared with a narrower one. Targeting a broad monetary aggregate captures a variety of assets that contribute to liquidity and aggregate demand, enhancing the effectiveness of monetary policy. Nonetheless, high elasticity of substitution between monetary assets has made it increasingly difficult to target money demand via changes in the interest rate. As a result, in 1999 the Swiss National Bank abandoned monetary targeting in favor of an expected inflation target.

     

Demand for money in the selected OECD countries: a time series panel data approach and structural breaks

Time series panel data estimation methods are used to estimate the cointegrating equations for the demand for money (M1) for a panel of 11 Organization for Economic Cooperation and Development (OECD) countries for which consistent quarterly data are available. The effects of financial reforms are analysed with structural break tests and estimates for alternative sub-samples. Our results for the post-reform sub-samples show that the income elasticity of the demand for money has decreased and response to interest rate changes has increased.     

International capital flows,liquidity risk,and monetary policy

In recent years, there has been a large amount of lending coming from the public sector of many developing countries. At the same time, the financial sectors in many advanced countries have issued a large share of portfolio debt to other countries. What are the implications of these events for the global financial system and overall economic activity? Do they have an impact on the transmission channels of monetary policy across countries at different stages of economic development? We investigate these important issues using a micro-founded model of money and banking so that the effects of monetary policy across countries can be meaningfully studied. Notably, the increase in capital outflows to the advanced economy renders monetary policy in developing countries to be less effective, while the effects of monetary policy in advanced economies are more pronounced. Yet, our results indicate that it can indeed be optimal for lower income countries to lend to the advanced world. Importantly, we find that the optimal amount of lending to advanced countries critically depends on the degree of liquidity risk — if it is sufficiently high, then public sector lending to advanced economies is not warranted. Consequently, our results indicate that governments in developing countries should carefully consider how much capital they send abroad to foreign countries.     

HOUSING WEALTH AND U.S. MONEY DEMAND: A PANEL ESTIMATION

This article estimates a panel model for U.S. money demand using annual state‐level data for the period from 1977 to 2008. We incorporate housing wealth in the demand‐for‐money function and find strong evidence of a relationship between a broad monetary aggregate and housing wealth. This finding is robust to the inclusion of variables measuring financial heterogeneity across U.S. regions. Breaking up the sample in two subperiods shows that panel estimates including housing wealth yield more stable coefficients than both time‐series estimates and panel estimates excluding housing wealth. We also show that the link between money and housing wealth predates the recent boom‐and‐bust cycle. (JEL E41, E52)     

Stability of Money Demand and Monetary Policy in Papua New Guinea (PNG): An Error Correction Model Analysis

An error correction model (ECM) is used to study the Properties of money demand and to evaluate the appropriate monetary policy in PNG. The study confirms that the determinats of money demand are real GDP, nominal interest and inflation rate. The income elasticity of money demand is very low. The demand for money in PNG was stable during 1979-95, suggesting that the monetary targeting regime by the PNG Central Bank is feasible. However, as PNG proceeds with economic reforms that Includes financial sector reform and a floating exchange rate regime, the stability of the demand for money may have to be re-examined periodically. The best approach for conducting the monetary policy in PNG is to target the inflation rate. [E41, E52, C22]     

Globalization,Financial Liberalization and the Behavior of the Long Run Money Demand in the Bangladesh Economy

ABSTRACT

The paper estimates the long run demand for money function in the Bangladesh economy using cointegration and the Vector Error Correction Modeling (VECM) technique. The cointegration results suggest that although the process of globalization has shown no significant impact on money demand by the fact that the foreign interest rate is seen as statistically not significant, the financial liberalization has an important impact, reflected in the statistically significant role of domestic interest rate, in influencing both M1 and M2 money demand. An estimate of VECMs also reveals the fact that the short run speed of adjustment is moderately influenced by the financial reform measures to establish the long run relation between money balances, income and domestic interest rates. The phenomenon of credit constraint in the context of a developing country has shown no significant role in influencing money demand, which may imply that the stage of financial development is getting higher level in the Bangladesh economy. The existence of exchange rate depreciation in the cointegration relation with the expected sign suggests that currency substitution is now effective in the monetary sector and, therefore, its impact should be considered in the Bangladesh monetary policy matrix.     

A panel data approach to the demand for money and the effects of financial reforms in the Asian countries

Alternative panel data estimation methods are used to estimate the cointegrating equations for the demand for money (M1) for a panel of 14 Asian countries from 1970 to 2005. The effects of financial reforms are analyzed with estimates for two sets of sub-samples and two break dates. Our results show that money demand function has been stable and financial reforms are yet to have any significant effects. Since there is no evidence for instability in the demand for money, the central banks of these countries should use money supply, instead of the rate of interest, as the monetary policy instrument.     

How justified is abandoning money in the conduct of monetary policy in Australia on the grounds of instability in the money‐demand function?

The role of money in the design and conduct of monetary policy has reemerged as an important issue in both advanced and developing economies, especially since the 2007 global financial crisis. A growing body of recent literature suggests that the causal relationship between money supply growth and inflation remains intact across countries and over time and that this relation is not conditional on the stability of the money‐demand function or whether money is endogenous or exogenous. Moreover, critical for a rule‐based monetary policy is the presence of a long‐run stable money‐demand function, rather than a short‐run money‐demand model that may exhibit instability for many reasons, including problems with estimating a money‐demand model with high‐frequency data. Provided that a stable money‐demand function exists, it could be useful to establish long‐run equilibrium relations among money, output, prices, and exchange rates, as the classical monetary theory suggests. Within this analytical framework, this paper addresses the question of whether money has any role in the conduct of monetary policy in Australia. The conventional wisdom is that the money‐demand function in Australia has been unstable since the mid‐1980s due to financial deregulation and reforms; this led to a change in the strategy of monetary policy for price stability in the form of inflation targeting that ignores money insofar as inflation and its control are concerned. This paper reports empirical findings for Australia, obtained from a longer quarterly data series over the period 1960Q1–2015Q1, which suggest that instability in the narrow‐money‐demand function in Australia was primarily due to the exclusion of variables which have become important in the deregulated environment since the 1980s. These findings are confirmed by an expanded form of the narrow‐money‐demand function that was found stable over the past two decades, although it experienced multiple structural breaks over the study period. The paper draws the conclusion that abandoning the monetary aggregate as an instrument of monetary policy in Australia, under a rule‐based monetary policy such as inflation targeting, cannot be justified by instability in the money‐demand function or even by lack of a causal link between money supply growth and inflation.     

The (in)stability of money demand in the euro area: lessons from a cross-country analysis

The instability of standard money demand functions has undermined the role of monetary aggregates for monetary policy analysis in the euro area. This paper uses country-specific monetary aggregates to shed more light on the economics behind the instability of euro area money demand. Our results obtained from panel estimation indicate that the observed instability of standard money demand functions could be explained by omitted variables like e.g. technological progress that are important for money demand but constant across member countries.     

中国"超额货币"成因的进一步检验

中国的超额货币一直是理论界颇有争议的话题,因而关于超额货币成因的理论假说有很多种。基于对以往的理论假说进行总结与质疑的基础上,利用货币需求的收入弹性与价格弹性对交易方程式进行调整,并利用中国1991-2003年的数据对调整后的模型进行检验,结果发现:货币需求的收入弹性与价格弹性的变化是导致中国超额货币存在的主要原因。     

Money,liquidity and welfare

This paper develops an analytically tractable Bewley model of money demand to shed light on some important questions in monetary theory, such as the welfare cost of inflation. It is shown that when money is a vital form of liquidity to meet uncertain consumption needs, the welfare costs of inflation can be extremely large. With log utility and parameter values that best match both the aggregate money demand curve suggested by Lucas (2000) and the variance of household consumption, agents in our model are willing to reduce consumption by 3–4% to avoid 10% annual inflation. The astonishingly large welfare costs of inflation arise because inflation increases consumption risk by eroding the buffer-stock-insurance value of money, thus hindering consumption smoothing at the household level. Such an inflation-induced increase in consumption risk at the micro level cannot be captured by representative-agent models or the Bailey triangle. Although the development of financial intermediation can mitigate the problem, with realistic credit limits the welfare loss of moderate inflation still remains several times larger than estimations based on the Bailey triangle. Our findings provide a strong justification for adopting a low inflation target by central banks, especially in developing countries where money is the major form of household financial wealth.     

Wealth and the demand for money in the European Union

This study presents the results of an empirical analysis of the demand for money in the European Union as a whole over the period 1971–1995, with a particular focus on the impact of financial wealth. The empirical evidence shows a substantial impact of wealth on the demand for M2 and M3, whereas no influence of wealth on the demand for M1 is found. This finding may explain the remarkable increase of the broad monetary aggregates over the last decade or so. This means that taking into account the growth of wealth, the monetary expansion has been fairly modest. The evidence thus indicates that the strong increase of M2 and M3 should be attributed to portfolio investment considerations rather than to an expansionary monetary policy.Helpful comments by two anonymous referees, the participants in the Workshop on Money Demand at the Humboldt Universität and Hans Lunsing gratefully acknowledged.     

Stock prices and money velocity: a multi-country analysis

What kind of information do stock prices offer for predicting velocity? This paper develops previous work by Milton Friedman for the US economy and shows that in a panel of 25 countries a wealth effect derived from the stock market has negatively influenced the ratio of nominal income to a broad definition of money. Taking quarterly data for the period 1961–1998, the relationship holds in Japan, the UK and Switzerland; in Italy a substitution effect (away from money) has also been operating. Overall, these empirical findings indicate the presence of systematic influences of stock price fluctuations on money velocity and suggest that the repercussions of asset inflation and deflation on the behavior of monetary aggregates should be monitored. First version received: July 1998/Final version received: November 2000     

A stable demand for money despite financial crisis: the case of Venezuela

The demand for broad money in Venezuela is investigated over a period of financial crisis and substantial exchange rate fluctuations. The analysis shows that there exist a long-run relationship between real money, real income, inflation, the exchange rate and an interest rate differential, that remains stable over major policy changes and large shocks. The long-run properties emphasize that both inflation and exchange rate depreciations have negative effects on real money demand, whereas a higher interest rate differential has positive effects. The long-run relationship is finally embedded in a dynamic equilibrium correction model with constant parameters. These results have implications for a policy-maker. In particular, they emphasize that with a high degree of currency substitution in Venezuela, monetary aggregates will be very sensitive to changes in the economic environment.     

On the empirical specification of the European demand for money

This paper tests several aspects concerning the specification of an empirical demand for money function for the European Monetary Union. The econometric results show that wealth is a statistically significant determinant for the demand for money. A homogeneous sample period is statistically established, and a demand equation for liquid assets (other than strict money) is presented. A new method to weight and add national variables is also suggested to obtain European aggregates. The main policy implication is that monetary aggregate targeting should not be the main basis for monetary policy implementation.