The impact of economic and monetary uncertainty on the demand for money in emerging economies

By introducing uncertainty, monetary volatility and economic volatility are said to make the public cautious, hence increase their cash holdings or their demand for money. On the other hand, because of monetary and economic uncertainty if the public seek safer assets than money, they may hold less cash. In the absence of any paper testing for the impact of economic and monetary uncertainty on the demand for money in emerging economies, this article fills the gap by considering the experiences of six Central and Eastern European emerging economies and four other emerging economies. We found that the impact is transitory in most countries. Moreover, money demand is found correctly specified and stable in most countries, suggesting that policy based on monetary targeting could still be effective despite significant output and monetary uncertainty.     

Economic policy uncertainty and demand for money in Australia

The demand for money has received a great deal of attention in the empirical literature. This literature, however, has emphasized factors such as interest rate, income, inflation rate and exchange rate as the primary determinants of money demand. Although an emerging strand of literature examines uncertainty as a potential determinant of money demand, findings have been mixed. Using a news-based Economic Policy Uncertainty (EPU) index and Australian quarterly data from 1998 to 2017, we study the impact of policy uncertainty on demand for money. Autoregressive distributed lag (ARDL) results show that the economic policy uncertainty measure has a negative short-run effect on the demand for money, suggesting the wider public hedge against future expected inflation, and positive long-run effect, whereby the broader public hold more cash to stay liquid during times of economic uncertainty. Also, introducing nonlinearity into the money demand equation, we find an asymmetric effect, more in favour of currency appreciations, supporting the expectations effect of further appreciations in exchange rate movements.     

The demand for money in Austria

In this paper, the demand for real money M1, M2, and M3 is estimated for Austria over the time period 1965–96. The modelling takes place within the framework of a small vector autoregression. To estimate the demand for money, two-equation error-correction models are constructed, which contain the short-run dynamics and the long-run economic equilibrium. It is found that a stable money demand exists for all monetary aggregates. The long-run equilibrium of M1, after accounting for a structural break in 1979, can be characterised as a classical type of money demand, with no interest rate effects and an elasticity of one for real GDP. In the case of M2 and M3, we find a unit coefficient on income and a significantly negative influence of a long-term interest rate. The statistical properties of the estimated short-run money demand equations – considering in-sample and out-of-sample tests – are generally very good. First version received: October 1996/Final version received: April 2000     

A money demand system for German M3

A small macroeconomic model is constructed starting from a German money demand relation for M3 based on quarterly, seasonally unadjusted data for the period from 1976 to 1996. In contrast to previous studies we build a vector error correction model for M3, GNP, an inflation rate and an interest rate spread variable to represent opportunity costs of holding money. Furthermore, import price inflation is added as an exogenous variable. The model is used to analyze the relation between money growth and inflation by means of an impulse response analysis.We thank Gerd Hansen for soliciting two anonymous referee reports on an earlier version of this article and thereby helping in the editorial process for this volume. We are grateful to him, Timo Teräsvirta, Kirstin Hubrich and the two referees for comments that helped us to improve our paper. Financial support was provided by the DFG, Sonderforschungsbereich 373.     

A systemic approach to modelling and estimating demand for money(ies)

This article uses a consumer theory-based systemic approach to model the demand for monetary liquid asset holdings in Chile. We implement the suggestions and caveats of aggregation theory for the estimation of a demand system for liquid assets (monies) in static, dynamic and time-varying parameters setups. Our results are robust and theoretically consistent with consumer theory restrictions, as a system derived from a utility maximizing framework and a quasi concave utility function. In our estimations, we find stability of interest rate elasticities, in contrast to previous related literature. We also document evidence that long (short) maturity rates are associated to less (more) liquid assets.     

Endogeneity in European money demand

European wide monetary aggregates constructed from pre-unification data cannot be used as evidence that money demand in the euro area is stable. To overcome the Lucas critique, we apply the standard foreign exchange rate model. Since the uncoordinated country specific money supply system is abolished, the increased comovement between local monetary aggregates leaves little room for a free ride on the law of large numbers. Current monetary policy decisions must be based on untested relations, and given ‘the long and variable lags’, we conclude that the road towards monetary stability is a non-activist steady money supply policy.     

Policy Uncertainty and the Demand for Money in Korea: An Asymmetry Analysis

Previous studies included money supply volatility as well as output volatility as measures of uncertainty in estimating the demand for money. However, a more comprehensive measure of uncertainty is now constructed for many countries and is known as policy uncertainty. When we included this new measure in the formulation of the demand for money in Korea and relied upon a nonlinear specification of the money demand which allows us to assess the asymmetric effects of changes in the policy uncertainty measure, we found asymmetric long-run effects of policy uncertainty on the demand for cash in Korea. Our conjecture is that increased uncertainty induces Koreans to hold less cash in favor of safer assets and decreased uncertainty has opposite effects, though at different rate.     

Why does the velocity of money move pro‐cyclically?

The velocity of money usually rises in expansions and falls in recessions This paper explains this pro‐cyclical movement of velocity using two ideas: (i) during business cycles the movement of investment and consumption of durable goods has a larger amplitude than consumption of non‐durable goods and services; (ii) the velocity associated with expenditure on investment and durable goods is much higher than the velocity associated with consumption of non‐durable goods and services, because the former expenditures are synchronized with the attainment of money by economic agents whereas the latter are not. In this setting, the rise in the weight of expenditure in durable goods relative to the weight of non‐durable goods and services, which occurs during expansions, generates an increase in the average velocity of circulation. The opposite happens during recessions and thus velocity moves pro‐cyclically.     

Empirical modeling of money demand

This paper examines several central issues in the empirical modeling of money demand. These issues include economic theory, data measurement, parameter constancy, the opportunity cost of holding money, cointegration, model specification, exogeneity, and inferences for policy. Review of these issues at a general level is paralleled by discussion of specific empirical applications, including some new results on the demand for narrow money in the United Kingdom.The author is a staff economist in the Division of International Finance, Board of Governors of the Federal Reserve System, Washington, DC 20551 USA, and may be reached on the Internet at ericsson@frb.gov. The views in this paper are solely the responsibility of the author and should not be interpreted as reflecting the views of the Board of Governors of the Federal Reserve System, the Reserve Bank of Australia, or any other person associated with the Federal Reserve System or the Reserve Bank of Australia. I am grateful for the generous hospitality of the Reserve Bank of Australia, where I was on secondment when this research was begun. I also wish to thank Tony Brennan, Gordon de Brouwer, Julia Campos, Ed Nelson, Jerome Fahrer, Jon Faust, Steve Grenville, David Hendry, John Irons, Katarina Juselius, Neva Kerbeshian, Helmut Lütkepohl, Dieter Nautz, Athanasios Orphanides, Kevin Prestwich, Robert Subbaraman, Timo Teräsvirta, Jenny Wilkinson, Jürgen Wolters, and two anonymous referees for helpful comments and discussions. All numerical results were obtained using PcGive Professional Version 9.0; see Doornik and Hendry (1996). This paper is a condensed version of Ericsson (1998), which provides additional empirical and analytical examples and more extensive references. The data may be obtained from the Internet at http://wotan.wiwi.hu-berlin.de/oekonometrie/engl/data.html.     

货币需求弹性、有效货币供给与货币市场非均衡模型——解析"中国之谜"与长期流动性过剩

Chinese excessive liquidity problems are more serious than other main countries. The upgrading industrial structure and the increasing opening degree lead to the excessive money demand and higher money demand elasticity. Bad credits weaken money supply effectiveness and lead to illusive increasing money. We set up the money market disequilibrium model under the condition of the excessive liquidity. The imbalance between money demand and money supply is the key of Chinese excessive liquidity problems. __________ Translated from Jingji lilun yu jingji guanli 经济理论与经济管理(Economic Theory and Business Management), 2007, (11): 38–44     

Broad money demand and financial liberalization in Greece

This paper develops a constant, data-coherent, equilibrium correction model for broad money demand (M3) in Greece over 1976–1994. The aggregate M3 was targeteduntil recently, and current monetary policy still uses such aggregates as guidelines. In spite of financial innovation, financial liberalization, and large fluctuations in the inflation rate, the estimated model is remarkabli stable. Dynamics are important, with price and income elasticities being much smaller in the short run than in the long run. The model provides a better understanding of the portfolio consequences of financial innovation and the effects of monetary policy in Greece.The authors are staff economists in the Division of International Finance, Federal Reserve Board, Washington, DC 20551 USA, and the Research Department, International Monetary Fund, Washington, DC 20431 USA, respectively. They may be reached on the Internet at ericsson@frb.gov and ssharma@imf.org. The views expressed in this paper are solely the responsibility of the authors and should not be interpreted as reflecting those of the Board of Governors of the Federal Reserve System, the International Monetary Fund, or other members of their staffs. We wish to thank the Bank of Greece for providing the data; Sophocles Brissimis, Nicholas Paleocrassas, and George Simigiannis for offering insights into institutional aspects of the Greek financial system; and Richard Agénor, Caroline Atkinson, Adi Brender, Julia Campos, Dimitri Demekas, David Hendry, Katarina Juselius, Tim Lane, Helmut Lütkepohl, Jaime Marquez, Jürgen Wolters, and two anonymous referees for useful comments. An earlier version of this paper appeared as Ericsson and Sharma (1996). All numerical results were obtained using PcGive Professional Versions 8 and 9: see Doornik and Hendry (1994a, 1994b, 1996, 1997) and Hendry and Doornik (1996). The data may be obtained from the Internet, http://wotan.wiwi.hu-berlin.de/ oekonometrie/engl/data.html     

Structural breaks, cointegration, and speed of adjustment Evidence from 12 LDCs money demand

This article estimates a theoretically coherent and empirically robust money demand function for 12 developing countries. The modeling procedure not only tests for a regime shift in the cointegrating equation, but also in the error correction model. Five specific hypotheses are examined. The article demonstrates that a long-run equilibrium relationship exists between real M1 or M2 balances, real income, inflation, exchange rate, foreign exchange risk, and foreign interest rates in the countries studied. The study provides information on the speed of adjustment to equilibrium and the median and mean time lags for adjustment of real money balances to changes in each determinant. Although our results provide more evidence against M1 than M2, this study clearly establishes that both M1 and M2 must be considered as viable policy tools for less developed countries.     

Hyperinflation in Zimbabwe: money demand,seigniorage and aid shocks

Zimbabwe experienced record hyperinflation of 80 billion per cent per month in 2008. This article uses new data from Zimbabwe to investigate money demand under hyperinflation using an autoregressive distributed-lag model for the period 1980–2008. The results produce plausible convergence rates and long-run elasticities, indicating that real-money balances are cointegrated with the inflation rate and signifying an equilibrium relationship between the two series. Evidence is also presented suggesting prices were driven by increases in the money supply rather than by changes in price setting behaviour. The article uses the estimated elasticity on the inflation variable to calculate the maximum level of seigniorage revenue that could be raised in the economy. Actual seigniorage levels increased dramatically after 2000, with inflation eventually exceeding the rate required to maximize this revenue stream. This is discussed in relation to international financing constraints and the collapse of the domestic tax base.     

Financial innovations and the future of monetary policy in Nigeria

This paper examines the implications of financial innovations on Nigeria’s monetary policy, using: trend analysis, error correction mechanism, and a structural model estimated with generalized method of moments. The study found that financial innovation improves the interest rate channel of monetary policy transmission, and the efficiency of the financial system. However, it increases the output gap and adds an element of uncertainty in the monetary policy environment as it increases the cost of implementing monetary policy and impinges on the potency of the operating target through its impact on the stability of the money multiplier, money velocity, and demand for money.     

The money demand and the loss of interest for the euro in Romania

We generalize a money demand micro-founded model to explain Romanians’ recent loss of interest for the euro. We show that the reason behind this loss of interest is a severe decline in the relative degree of the euro liquidity against that of the Romanian leu. Our empirical findings also suggest that the two currencies are rather complements than substitutes, providing thus evidence for a reduced level of monetary integration of Romania with the Euro area. These results put into question the interest for the euro adoption in the next period.     

Long run money demand in the EU: Evidence for area-wide aggregates

Long-run properties of EU-wide money aggregates are analysed. For each of the three aggregates considered-Currency, M1 and M3H-it is possible to obtain cointegrating relationships with GDP and interest rates (long or short term market interest rates). Results are not improved when traditional aggregates, obtained by aggregating existing national aggregates, are extended by the inclusion of various measures of Cross-Border Holdings. Specific attention is also paid to aggregation issues and the relative performance of area-wide and national equations. The results show that aggregation bias is not a major problem and that the relatively good area-wide performance is largely a consequence of a statistical averaging effect.gf.gfagan.hg.eunet.deBoth authors are in the Stage Three Division of the Monetary, Economics and Statistics Department of the European Monetary Institute. The authors would like to thank colleagues at the EMI and participants at an EMI conference on EU money demand, held in 1995, for helpful comments and suggestions. Comments received from participants in the 1997 Econometric Society European Meeting and in the Workshop on Money Demand at Berlin Humboldt Universität in 1997 are also gratefully acknowledged. The final version benefited from comments by the editors and two anonymous referees. Opinions expressed in the paper are only those of the authors and do not necessarily represent the views of the EMI.     

Asymmetric effects of exchange rate changes on the demand for money in China

In order to account for currency substitution, the majority of recent studies relating to the specification of the demand for money include the exchange rate as another determinant of the demand for money. However, those who have estimated the demand for money in China have been unable to find any significant effects of exchange rate changes on the demand for money by the Chinese. We show that this is due to the assumption that exchange rate changes have symmetric effects. Once depreciations are separated from appreciations of the yuan, those exchange rate changes are shown to have significant effects on the demand for money in China, but in an asymmetric manner.     

A monetary vector error correction model of the Euro area and implications for monetary policy

In this paper, a vector error correction model for Euro area money, prices, output, long-term interest rate and short-term interest rate with three identified cointegration relations is specified. It is shown that Euro area money and prices can be considered as variables that are integrated of order two or I(2), that is, they have to be differenced twice to become stationary. Accordingly, the relation between money, prices and other macroeconomic variables is analyzed in an econometric framework which is suited for the analysis of I(2)-variables. Monetary policy implications are derived from the estimated system.First revision received: May 2002/Final revision received: May 2003I thank Helmut Lütkepohl, Jürgen Wolters, and two anonymous referees for helpful comments. Financial support from the Deutsche Forschungsgemeinschaft (SFB 373) is 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     

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.