THE DEMAND FOR MONEY AND PRICE EXPECTATIONS IN AUSTRALIA

Abstract

IT IS FREQUENTLY SUGGESTED that the demand for real money balances depends on the expected rate of inflation. For example, Friedman [9] includes this variable amongst those which can be expected to influence the demand for money. He argues that the variable represents the return on one of the alternative ways in which wealth can be held-physical goods. The question of whether or not the anticipated rate of inflation belongs in the demand for money equation is an important one. Turnovsky [26] develops a model in which the inclusion of the expected rate of inflation in certain equations, including the demand for money function, causes it to have an influence on the real behaviour of the economy. Also, if the effect of monetary policy is to be predicted accurately the correct specification of the demand for money equation must be determined. However, investigators have frequently failed to detect the influence of this variable in studies based on actual data. Some recent exceptions are provided by the studies by Goldfeld [10] and Shapiro [23] for the United States, Smith and Winder [24] for Canada and Juttner and Tuckwell [11] and Lewis and Wallace [13] for Australia. The purpose of this study is to provide further empirical evidence for the Australian case. It differs from previous studies in a number of respects. For example, the process by which expectations are generated differs from the processes adopted in previous studies. It also has two additional aims which differentiate it from earlier studies. First, it considers the validity of aggregating the demands for certain monetary assets into a single demand for money function. Most of the studies mentioned above deal with a single monetary aggregate; Lewis and Wallace consider only the demand for savings deposits. This study reports separate equations explaining the demand for notes and coin and current (cheque) deposits. These assets have been chosen because they possess the common characteristic that they can be converted into cash on demand. Secondly, an aspect of the Australian banking system which has been ignored in previous studies is examined in this paper. Australian trading banks lend on the overdraft system and at any point in time there is a substantial amount available to borrowers in the unused portions of their overdraft accounts. It has frequently been argued that the value of this store of liquidity should be included in measures of the money supply. This proposition is tested by the equations reported in this paper.