Abstract
Past aggregate time-series studies, conducted under the assumption of a representative economic agent, frequently show that the demand for narrowly defined M1, especially non-interest-yielding demand deposit, is unstable during periods of financial innovations. Whether this is longitudinally the case among life-cycle savers is unclear. This study utilizes longitudinal data to take another look and find that volatility in the demand for non-interest-earning checking accounts in the mid and late 1990s is attributable solely to the portion held for the transactions motive. When the conventional Baumol-Tobin model is extended to include human capital and family formation variables representing the life-cycle motive, equilibrium money demand is a stable function of both economic and demographic variables.
Highlights
A stable money demand or velocity of money in circulation is theoretically a matter of fundamental importance in order for monetary policies to have predictable impacts on general economic activities, as suggested in the Keynesian IS-LM framework [20] and the classical quantity theory of money [16]
The purpose of this study is to examine the microfoundations of aggregate money demand and its stability during periods of financial innovations by utilizing longitudinal data within the frameworks of the inventory-theoretic transaction approach and the life-cycle hypothesis [2]
The longitudinal estimate of income elasticity for the entire 1996-1999 period is approximately 0.21, about eight-percentage points smaller than the 0.29 in the life-cycle model. This means that a rise real income by 100% would raise money demand by about 29% in the life-cycle model and only 21% in the simple model
Summary
A stable money demand or velocity of money in circulation is theoretically a matter of fundamental importance in order for monetary policies to have predictable impacts on general economic activities, as suggested in the Keynesian IS-LM framework [20] and the classical quantity theory of money [16]. The focus of cross-sections studies was on the relative importance of the scale variables determining long-run money demand, but the rate of interest was often omitted from the analysis because of the lack of micro data [2,5,22,23]. In the post-1990 literature, the attention has shifted to the search for a stable long-run aggregate money demand based on the cointegration approach. Findings in the early 1990s were inconclusive [6,7,15,25], while the banking reform and retail sweep programs of the 1994-1999 period have further challenged the existence of a stable long-run aggregate money demand in the United States [8,9,10,19]
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