An important concern of macroeconomic analysis is how interest rates affect the cash balance demanded at a certain level of nominal income. In fact, the interest-rate- elasticity of the liquidity demand determines the effectiveness of monetary policy, which is useless under absolute liquidity preference, i.e. when the money demand is perfectly elastic. An actuarial approach is developed in this paper for dealing with random income. Assuming investors face liquidity constraints, a level of surplus exists which maximises expected value. Moreover, the optimal liquidity demand is expressed as a Value at Risk and the comonotonic dependence structure determines the amount of money demanded by the economy. As a consequence, the interest-rate-elasticity depends on the kind of risks and expectations. The more unstable the economy, the greater the interest-rate-elasticity of the money demand. Moreover, part of the adjustment to reestablish the short-run monetary equilibrium may be performed through volatility shocks.
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Paper provided by University Library of Munich, Germany in its series MPRA Paper with number
2771.
Find related papers by JEL classification: E40 - Macroeconomics and Monetary Economics - - Money and Interest Rates - - - General E44 - Macroeconomics and Monetary Economics - - Money and Interest Rates - - - Financial Markets and the Macroeconomy E41 - Macroeconomics and Monetary Economics - - Money and Interest Rates - - - Demand for Money E58 - Macroeconomics and Monetary Economics - - Monetary Policy, Central Banking, and the Supply of Money and Credit - - - Central Banks and Their Policies E0 - Macroeconomics and Monetary Economics - - General E52 - Macroeconomics and Monetary Economics - - Monetary Policy, Central Banking, and the Supply of Money and Credit - - - Monetary Policy E12 - Macroeconomics and Monetary Economics - - General Aggregative Models - - - Keynes; Keynesian; Post-Keynesian
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