Interest Elasticity Of Money Demand Research Articles

Financial Innovations and the Interest Elasticity of Money Demand in Jordan (2009-2022)

This study aimed to determine the relationship between financial innovations and the interest elasticity of money demand, and based on a set of statistical tests, the ordinary least squares method was determined to achieve this goal.Using quarterly data on the Jordanian economy for the period (2009-2022), the study estimated the demand for money as a function of income and interest rate. The empirical results reached in this study showed that all determinants of money demand have the expected signs and were statistically significant. Regarding the relationship between financial innovations and the interest elasticity of money demand, the results indicated that financial innovations after 2016 reduced the sensitivity of money demand to interest rate. Therefore, the absolute value of the interest elasticity of money demand decreased, which means an increase in the effectiveness of monetary policy as financial innovations may improve the efficiency of the financial system, in a way that facilitates the work of monetary policy and increases its effectiveness. However, monetary policy makers must monitor these innovations and developments and limit the negative changes that may accompany them, and work to design a modern monetary policy that is in line with these developments.

The demand for money at the zero interest rate bound

SummaryThis paper undertakes both a narrow and wide replication of the estimation of a money demand function conducted by Ireland (American Economic Review, 2009). Using US data from 1980 to 2013, we show that the substantial increase in the money‐income ratio during the period of near‐zero interest rates is captured well by the log–log specification but not by the semi‐log specification, contrary to the result obtained by Ireland (2009). Our estimate of the interest elasticity of money demand over the 1980–2013 period is about one‐tenth that of Lucas's paper published in 2000, which used a log–log specification. Finally, neither specification satisfactorily fits post‐2015 US data.

Time-varying money demand and real balance effects

This paper presents an analysis of the stimulants and consequences of money demand dynamics. By assuming that household's money holdings and consumption preferences are not separable, we demonstrate that the interest-elasticity of demand for money is a function of the household's preference to hold real balances, the extent to which these preferences are not separable in consumption and real balances, and trend inflation. An empirical study of U.S. data revealed that there was a gradual fall in the interest elasticity of money demand of approximately one-third during the 1970s due to high trend inflation. A further decline in the interest-elasticity of the demand for money was observed in the 1980s due to the changing household preferences that emerged in response to financial innovation. These developments led to a reduction in the welfare cost of inflation that subsequently explains the rise in monetary neutrality observed in the data.

Time-Varying Money Demand and Real Balance Effects

This paper presents an analysis of the stimulants and consequences of money demand dynamics. By assuming that households’ money holdings and consumption preferences are not separable, we demonstrate that the interest-elasticity of demand for money is a function of the households’ preference to hold real balances, the extent to which these preferences are not separable in consumption and real balances, and trend inflation. An empirical study of U.S. data revealed that there was a gradual fall in the interest-elasticity of money demand of approximately one-third during the 1970s due to high trend inflation. A further decline in the interest-elasticity of the demand for money was observed in the 1980s due to the changing household preferences that emerged in response to financial innovation. These developments led to a reduction in the welfare cost of inflation that subsequently explains the rise in monetary neutrality observed in the data.

A TIME-VARYING APPROACH OF THE US WELFARE COST OF INFLATION

Money-demand specifications exhibit instability, especially for long spans of data. This paper reconsiders the welfare cost of inflation for the US economy using a flexible time-varying (TV) cointegration methodology to estimate the money-demand function. We find evidence that the TV cointegration estimation provides a better fit of the actual data than a time-invariant estimation and that the throughout unitary income elasticity only exists for the log–log form over the entire sample period. Our estimate of the welfare cost of inflation for a 10% inflation rate lies in the range of 0.025–0.75% of gross domestic product (GDP) and averages 0.27%. In sum, our findings fall well within the ranges of existing studies of the welfare cost of inflation. We find that the welfare cost averages 7.4% higher during expansions than recessions for 10% inflation rate. Finally, the interest elasticity of money demand shows substantial variability over our sample period.

Estimation of the liquidity trap using a panel threshold model

ABSTRACTThis empirical study investigates, unlike previous studies, the presence of a liquidity trap using firm-level data. The study focuses on the case of China. A panel threshold model is employed. The empirical estimation reveals that the interest elasticity of money demand declines as the interest rate falls, a finding indicating that China has not been in a liquidity trap.

Demand for M2 at the Zero Lower Bound: The Recent U.S. Experience

In this paper, we re-examine the relationship between money and interest rates with a focus on the past few years, when the opportunity cost of M2 has dropped below zero. Until the late 1980s, a stable relationship between monetary aggregates and the opportunity cost of holding money--measured as the spread between the three-month Treasury bill yield and the deposit-weighted average return on M2 assets--existed, and played an integral role in the conduct of monetary policy (e.g., Moore et al.(1990)). This relationship broke down in the early 1990s, when M2 velocity increased beyond the range that could be explained by movements in M2 opportunity cost. As of the mid-2000s, a new relationship was emerging, but was still statistically unstable. In late 2008, the opportunity cost of holding money dropped precipitously and has remained at its zero lower bound. Standard money-demand theory indicates that in such cases the interest elasticity of money demand should rise sharply. Reviewing the evidence to date, we fail to find support for such a rise through 2011, but we observe a notable change in the relationship over the most recent quarters. We conjecture that the more recent shifts, however, could be due to the effects of regulatory and monetary policy changes rather than a fundamental shift in the relationship between money and opportunity cost. Further work is needed to determine the contribution of these regulatory and monetary policy factors.

Demand for M2 at the Zero Lower Bound: The Recent U.S. Experience

In this paper, we re-examine the relationship between money and interest rates with a focus on the past few years, when the opportunity cost of M2 has dropped below zero. Until the late 1980s, a stable relationship between monetary aggregates and the opportunity cost of holding money--measured as the spread between the three-month Treasury bill yield and the deposit-weighted average return on M2 assets--existed, and played an integral role in the conduct of monetary policy (e.g., Moore et al. (1990)). This relationship broke down in the early 1990s, when M2 velocity increased beyond the range that could be explained by movements in M2 opportunity cost. As of the mid-2000s, a new relationship was emerging, but was still statistically unstable. In late 2008, the opportunity cost of holding money dropped precipitously and has remained at its zero lower bound. Standard money-demand theory indicates that in such cases the interest elasticity of money demand should rise sharply. Reviewing the evidence to date, we fail to find support for such a rise through 2011, but we observe a notable change in the relationship over the most recent quarters. We conjecture that the more recent shifts, however, could be due to the effects of regulatory and monetary policy changes rather than a fundamental shift in the relationship between money and opportunity cost. Further work is needed to determine the contribution of these regulatory and monetary policy factors.

The Recent Financial Deregulation and the Interest Elasticity of the Simple M1 Demand Function: An Empirical Note

The main objective of this note is to examine whether the interest elasticity of money demand has increased during the last few years. A simple money demand regression that includes additional intercept and slope dummy variables defined over the interval 1981.01 to 1985.03 is estimated for the whole sample period 1961.01-1985.03. The regression results show that the elasticity of money demand with respect to market interest rates has for now increased. No shifts are detected in income and time trend elasticities. The in-sample predictions of the more interest-sensitive money demand regression are broadly consistent with the actual behavior of Ml observed so far in the 1980s. The residuals also suggest that the MI demand function has been subject to transitory shocks over the same period.

On the welfare cost of inflation in Europe

This article follows Lucas (2000) and Serletis and Yavari (2005) and estimates the welfare cost of inflation in the Euro zone. It uses recent advances in the field of applied econometrics to estimate the interest elasticity of money demand and reports that the welfare cost of inflation is lower in big countries than it is in small countries.

Policy instrument choice and non-coordinated monetary policy in interdependent economies

Non-coordinated monetary policy is analyzed in a stochastic two-country general equilibrium model. Non-coordinated equilibria are compared in two cases: one where policy is set in terms of state-contingent money supply rules, and one where policy is set in terms of state-contingent nominal interest rate rules. In general, the non-coordinated equilibrium differs between the two types of policy rule, but a number of special cases are identified where the equilibria are identical. The endogenous choice of policy instrument is analyzed and the Nash equilibrium in the choice of policy instrument is shown to depend on the interest elasticity of money demand.

The welfare cost of inflation in Italy

This paper follows Lucas (2000), and Serletis and Yavari (2004) and estimates the welfare cost of inflation in Italy. It uses recent advances in the field of applied econometrics to estimate the interest elasticity of money demand in Italy and reports welfare cost estimates close to those reported by Serletis and Yavari for Canada and the USA, but an order of magnitude smaller than those reported by Bullard and Russell (2004) for the US economy.

Inflation and Balanced‐Path Growth with Alternative Payment Mechanisms

The paper shows that contrary to conventional wisdom an endogenous growth economy with human capital and alternative payment mechanisms can robustly explain major facets of the long run inflation experience. A negative inflation-growth relation is explained, including a striking nonlinearity found re-peatedly in empirical studies. A set of Tobin (1965) effects are also explained and, further, linked in magnitude to the growth effects through the interest elasticity of money demand. Undis-closed previously, this link helps fill out the intuition of how the inflation experience can be plausibly explained in a robust fashion with a model extended to include credit as a payment mechanism.

The welfare cost of inflation in Canada and the United States

This paper follows Lucas (Econometrica 68 (2000) 247) and estimates the welfare cost of inflation in the post-World War II Canadian and U.S. economies. We use recent advances in the field of applied econometrics to estimate the interest elasticity of money demand and report significantly smaller welfare costs estimates than Lucas (Econometrica 68 (2000) 247).

Policy Rules and Monetarist Arithmetic

This note demonstrates the existence of an important equilibrium path overlooked in the literature on monetarist arithmetic. Pleasant monetarist arithmetic is possible when the interest‐elasticity of money demand exceeds unity. In this case, tight money may lead to a transitory increase in seigniorage, the retirement of government debt, and lower inflation in both the short run and the long run. The set of equilibrium paths is sensitive, however, to the form of the policy rule. Pleasant monetarist arithmetic is not an equilibrium if the policy rule fixes the share of the fiscal deficit financed by seigniorage. Both pleasant monetarist arithmetic and the tight‐money paradox are equilibrium paths when the government's commitment to low money growth is conditional on inflation remaining below its previous level.

IS-LM and Monetarism

This paper discusses monetarist objections to the IS-LM model. We explore the views of two principal spokesmen for monetarism: Milton Friedman and the team of Karl Brunner and Allan Meltzer. Friedman did not explicitly state the reasons he generally chose not to use the IS-LM model in rejecting Keynesian views on the demand function for money, the role of autonomous expenditures in cyclical fluctuations, the potency of fiscal policy as against monetary policy, etc. He presented statistical findings, historical evidence, and econometric results to support his alternative analysis of macroeconomics, but his critics were unconvinced. In 1970, in an effort to use his critics' common language, he set up a model with explicit terms for IS-LM to encompass both the quantity theory and the income-expenditure theory. Friedman attributed the failure of this effort to the fact that he was a Marshallian, his opponents Walrasians. Brunner and Meltzer's objections to IS-LM were explicit. They found it too spare, so they elaborated it by adding a credit market, disaggregating the asset market by specifying three assets: base money, government debt, and real capital. They set up a model with financial institutions and utilized it to study the effects of a variety of policies. In brief, summarizing the views of both Friedman and Brunner and Meltzer, monetarists dislike the IS-LM framework because it limits monetary influence too narrowly, essentially to the interest elasticity of money demand, and defines investment in an excessively narrow fashion, and even that is not explicit.

The term structure of interest rates and the demand for money

This paper investigates the money demand behaviour when the entire term structure of interest rates is taken into account. The results show that the interest elasticity of money demand does not vary with the level of the term structure of interest rates. It is also found that the quantity of money demanded varies directly with the tilt of the term structure. Both these findings have useful implications for macroeconomic policy and analysis.

The time‐varying performance of the long‐run demand for money in the United States

This article investigates the issues of the stability and predictability and interest‐sensitivity of money demand over 1870–1997. Two different estimation methodologies are used ‐ random coefficient (RC) modeling and vector error correction (VEC) modeling. The former procedure allows the profiles of the coefficients to be traced over time and relaxes several restrictions routinely imposed in applied work. The results indicate that different estimation methodologies using different data periods and frequencies yield estimates of some of the coefficients of the long‐run demand for money that fall within a fairly narrow range. The results also suggest that specification errors have had an important influence on the time profile of the interest elasticity of money demand and that there is a tendency for the interest elasticity to decline in absolute value as interest rates decline.

The time-varying performance of the long-run demand for money in the United States

This article investigates the issues of the stability and predictability and interest-sensitivity of money demand over 1870-1997. Two different estimation methodologies are used - random coefficient (RC) modeling and vector error correction (VEC) modeling. The former procedure allows the profiles of the coefficients to be traced over time and relaxes several restrictions routinely imposed in applied work. The results indicate that different estimation methodologies using different data periods and frequencies yield estimates of some of the coefficients of the long-run demand for money that fall within a fairly narrow range. The results also suggest that specification errors have had an important influence on the time profile of the interest elasticity of money demand and that there is a tendency for the interest elasticity to decline in absolute value as interest rates decline.

Domestic Fiscal Policy in a Monetary Union: What are the Spillovers? / Fiskalpolitik in einer Währungsunion: Internationale Auswirkungen

Summary This paper examines the spillovers of domestic fiscal expansion in a monetary union. Such a policy action leads to cross-country crowding-out effects on the one hand and cross-country multiplier effects on the other. The overall effect is indeterminate a priori. The approach pursued is therefore an empirical one, using a computable general equilibrium (CGE) model with a simple representation of the money market. Three groups of parameters are identified as key determinants of the fiscal policy spillover: the elasticities of substitution in foreign trade (being a measure of the degree of trade integration), the interest elasticity of money demand, and the elasticity of wages with respect to the employment situation. For a reasonable range of parameter configurations, the interest rate effect always dominates the multiplier effect. Especially, even with a degree of trade integration four times as high as commonly assumed the overall spillover is (slightly) negative.