Modeling buffer stock money: an appraisal

Abstract

The buffer stock role of absorbing temporary discrepancies between the purchases and sales is assigned to money because money, being the most liquid of all assets, performs the buffer function best. The buffer stock approach will have important policy implications if it can help account for the apparent instability in conventional money demand models. Also, if the buffer stock model is valid, a strong case can be made for medium term monetary targeting despite the instability of conventional models. However, as this paper shows, the attempts to model the buffer stock role have led to certain incoherencies. While the buffer stock theory offers novel insights into the workings of a monetary economy, that theory awaits an empirical model that can serve as a test of its validity.