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The Demand for Money in a Stochastic Environment

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Author Info
Joseph Atta-Mensah

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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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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
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Handle: RePEc:bca:bocawp:04-7

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Related research
Keywords: Monetary aggregates;

Find related papers by JEL classification:
E41 - Macroeconomics and Monetary Economics - - Money and Interest Rates - - - Demand for Money
E50 - Macroeconomics and Monetary Economics - - Monetary Policy, Central Banking, and the Supply of Money and Credit - - - General
G11 - Financial Economics - - General Financial Markets - - - Portfolio Choice; Investment Decisions

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References listed on IDEAS
Please report citation or reference errors to , or , if you are the registered author of the cited work, log in to your RePEc Author Service profile, click on "citations" and make appropriate adjustments.:
  1. 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. [Downloadable!] (restricted)
  2. Fischer, Stanley, 1975. "The Demand for Index Bonds," Journal of Political Economy, University of Chicago Press, vol. 83(3), pages 509-34, June. [Downloadable!] (restricted)
  3. Merton, Robert C., 1971. "Optimum consumption and portfolio rules in a continuous-time model," Journal of Economic Theory, Elsevier, vol. 3(4), pages 373-413, December. [Downloadable!] (restricted)
    Other versions:
  4. 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. [Downloadable!] (restricted)
    Other versions:
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Cited by:
(explanations, Please report citation or reference errors to , or , if you are the registered author of the cited work, log in to your RePEc Author Service profile, click on "citations" and make appropriate adjustments.)

  1. Joseph Atta-Mensah, 2004. "Money Demand and Economic Uncertainty," Working Papers 04-25, Bank of Canada. [Downloadable!]
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This page was last updated on 2009-11-24.

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