Policy Uncertainty and the Demand for Money in the United States

Abstract

Previous studies that included any uncertainty measure in the specification of the demand for money in the U.S. derived their measures either from volatility of nominal money supply or volatility of real GDP. However, other factors such as taxes, spending, regulation, the Fed’s announcements, budget deficits, etc. could also contribute to an uncertain environment. A new measure of uncertainty that accounts for all these factors is now constructed and published. In this paper we include this comprehensive new measure known as “policy uncertainty” in estimating the demand for M2 in the U.S. Empirical results show that this new uncertainty measure has short-run and long-run positive effect, implying that due to policy uncertainty Americans hold more cash and this could contribute to a prolonged recession. JEL Classification: E41