Money demand

Money facilitates numerous transactions which would not have taken place in a barter economy. As a consequence, money represents generalized purchasing power over goods and services. Since every transaction involves money, economists have endeavoured to link the quantity of money with the value of economic transactions in the economy by developing theories explaining why people wish to hold money. The development of the various theories on the money demand function has resulted in voluminous empirical studies. Generally, the results of these empirical studies suggest a stable relationship between monetary aggregates and income. This is important because a stable and predictable money demand function will enable monetary authorities to forecast and to control inflation effectively. Nevertheless, the effect of financial liberalization and financial innovations in the 1980s convinced monetary authorities in both the developed and developing countries to de-emphasize the use of·monetary aggregates in the transmission of monetary policy and to use interest rates instead as the policy indicator for their monetary policy purposes. Ever since then economists have tried to find ways to restore monetary aggregates to its 'rightful place' as the main monetary policy indicator. The continuing quest for a stable money demand function has been considered on both theoretical and empirical grounds. In explaining the underlying determinants of desired money holdings, researchers have incorporated the effects of technological changes such as improvements in electronic payments systems, employing 'refined' econometric techniques in particular the use of the cointegration approach, and new financial assets into multi-asset portfolio models. However, as Duca and Vanhoose (2004: p.266) state "it remains to be seen, however, whether the empirical advances in money demand literature will both adequately keep pace with financial progress and have a practical impact on the conduct of monetary policy". In other words, given the availability of data and methods, searching for a stable money demand function so . as to support an effective monetary policy action is an empirical question.

Text 120892.pdf - Published Version Download (2MB)

Actions (login required)

View Item