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The Demand for Money in a Stochastic Environment

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  • Joseph Atta-Mensah

Abstract

The author re-examines the demand-for-money theory in an intertemporal optimization model. The demand for real money balances is derived to be a function of real income and the rates of return of all financial assets traded in the economy. Unlike the traditional money-demand relation, however, where the elasticities are assumed to be constant, the coefficients of the explanatory variables are not constant and depend on the degree of an agent’s risk aversion, the volatilities of the price level and income, and the correlation of asset returns. The author shows that the response of households to increased volatilities in the financial markets, economic activity, and prices cannot be predicted, because a rise in general uncertainties has an ambiguous impact on the demand for money. This suggests that increased uncertainty is not very helpful for the planning decisions of households, because the optimal level of money holdings in the period of uncertainty cannot be ascertained.

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Bibliographic Info

Paper provided by Bank of Canada in its series Working Papers with number 04-7.

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Length: 29 pages
Date of creation: 2004
Date of revision:
Handle: RePEc:bca:bocawp:04-7

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Keywords: Monetary aggregates;

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References

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  1. Frenkel, Jacob A & Jovanovic, Boyan, 1980. "On Transactions and Precautionary Demand for Money," The Quarterly Journal of Economics, MIT Press, vol. 95(1), pages 25-43, August.
  2. Akerlof, George A & Milbourne, Ross D, 1980. "The Short Run Demand for Money," Economic Journal, Royal Economic Society, vol. 90(363), pages 885-900, December.
  3. R. C. Merton, 1970. "Optimum Consumption and Portfolio Rules in a Continuous-time Model," Working papers 58, Massachusetts Institute of Technology (MIT), Department of Economics.
  4. Fischer, Stanley, 1975. "The Demand for Index Bonds," Journal of Political Economy, University of Chicago Press, vol. 83(3), pages 509-34, June.
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Cited by:
  1. Seitz, Franz & von Landesberger, Julian, 2010. "Household money holdings in the euro area: An explorative investigation," Working Paper Series 1238, European Central Bank.
  2. Joseph Atta-Mensah, 2004. "Money Demand and Economic Uncertainty," Working Papers 04-25, Bank of Canada.

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