Revisiting the demand for money model: money and loans in selected manufacturing industries

Abstract

Using a dynamic infinite horizon optimizing model, it is shown that the empirical demand for money equation employed by a generation of applied monetary researchers is a reduced form model of the dynamic Euler equations for real money balances. The Euler equations derived in this paper focus on the finance capital for the firm and consist of real money balances (M1) and real business loans (F1) for selected manufacturing industries. By employing explicit structural dynamic specification and sectoral disaggregation, the question of how firms close the gap between desired real money balances and actual real money balances is examined. Model consistent ‘desired’ levels of money balances and business loans are found to depend not only upon the usual transactions variable and interest rate but also upon relative prices and a technology index. Moreover, the speed in closing the gap between desired and actual money balances (loan balances) is estimated using annual two-digit Standard Industrial Code data for durable and non-durable industries. Non-durable industries tend to close the gap faster than durable industries by as much as 25% in a given year.