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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.

Suggested Citation

  • Joseph Atta-Mensah, 2004. "The Demand for Money in a Stochastic Environment," Staff Working Papers 04-7, Bank of Canada.
  • Handle: RePEc:bca:bocawp:04-7
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    References listed on IDEAS

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    1. Jacob A. Frenkel & Boyan Jovanovic, 1980. "On Transactions and Precautionary Demand for Money," The Quarterly Journal of Economics, Oxford University Press, vol. 95(1), pages 25-43.
    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. 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.
    4. Fischer, Stanley, 1975. "The Demand for Index Bonds," Journal of Political Economy, University of Chicago Press, vol. 83(3), pages 509-534, June.
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    Cited by:

    1. Joseph Atta-Mensah, 2004. "Money Demand and Economic Uncertainty," Staff Working Papers 04-25, Bank of Canada.
    2. Franz Seitz & Julian von Landesberger, 2014. "Household Money Holdings in the Euro Area: An Explorative Investigation," Journal of Banking and Financial Economics, University of Warsaw, Faculty of Management, vol. 2(2), pages 83-115, November.

    More about this item

    Keywords

    Monetary aggregates;

    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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