Time-Varying Money Demand and Real Balance Effects

Abstract

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.

Switching volatility in a nonlinear open economy

“…In addition, we …nd that US money shocks a¤ect the EA real variables in the long run as well as the …nancial markets in the EA and United States (Appendix D). We therefore extend the literature by highlighting new transmission channels of money compared with other studies using linear closed-economy DSGE models with money Fourçans, 2012, 2017;Benchimol and Qureshi, 2020). Unlike this body of the literature, we show the role of money in the economy without assuming nonseparability between money and consumption (Benchimol, 2016), or a cash-in-advance constraint (Feenstra, 1986) or money in the production function (Benchimol, 2015).…”

Do retail traders destabilize financial markets? An investigation surrounding the COVID-19 pandemic

“…Therefore, in the spirit of Shambaugh (2008) , Forbes et al. (2018) , Benchimol and Qureshi (2020) , we construct implied difference measures from our state-dependent impulse responses, which explicitly control for the different responses of retail trading. We define as the implied difference of our relevant -variable to retail trading at horizon as: where is the impulse response of our -variable (i.e., range or GARCH(1,1) volatility) at horizon and is the response of retail trading at horizon where .…”

The discount factor for expected fundamentals: Evidence from a panel of 25 exchange rates

“…The gap becomes larger as the forecast horizon for the expected exchange rate increases. A possible theoretical explanation for this finding is that developing countries tend to have higher levels of inflation and nominal interest rates, which leads to a lower interest semi-elasticity of money demand in the general-equilibrium monetary models of Obstfeld and Rogoff (2003) and Benchimol and Qureshi (2020). In the money income model (Engel and West, 2005) a lower interest semi-elasticity of money demand implies a lower discount factor.…”