Liquidity preference as rational behaviour under uncertainty
AbstractAn 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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Bibliographic InfoPaper provided by University Library of Munich, Germany in its series MPRA Paper with number 2771.
Date of creation: 30 Nov 2006
Date of revision:
Money demand; Monetary policy; Economic capital; Distorted risk principle; Value-at-Risk;
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
This paper has been announced in the following NEP Reports:
- NEP-ALL-2007-04-21 (All new papers)
- NEP-CBA-2007-04-21 (Central Banking)
- NEP-MAC-2007-04-21 (Macroeconomics)
- NEP-MON-2007-04-21 (Monetary Economics)
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