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Modeling U.S. households' demand for liquid wealth in an era of financial change

  • Sean Collins
  • Richard G. Anderson

Money demand models overpredicted M2 growth in the United States from 1990 to 1993. We examine this overprediction using a model of household demand for liquid wealth. The model is a dynamic generalization of the almost-ideal demand model of Deaton and Muellbauer (1980). We find that the own-price elasticity of money demand rose substantially after 1990. We also find important cross-price elasticities of money with respect to other liquid financial assets, notably with respect to mutual funds. Incorporating these and other features helps explain nearly 50 percent of the shortfall in M2 growth over the period in question. It also suggests that households respond more rapidly to changes in market interest rates than is assumed in some limited-participation general equilibrium macroeconomic models.

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Paper provided by Federal Reserve Bank of St. Louis in its series Working Papers with number 1997-014.

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Date of creation: 1997
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Publication status: Published in Journal of Money, Credit, and Banking, February 1998
Handle: RePEc:fip:fedlwp:1997-014
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  1. Ng, S., 1995. "Testing for Homogeneity in Demand Systems when the Regressors Are Non-Stationary," Cahiers de recherche 9516, Centre interuniversitaire de recherche en ├ęconomie quantitative, CIREQ.
  2. Anderson, G J, 1991. "Expenditure Allocation across Nondurables, Services, Durables and Savings: An Empirical Study of Separability in the Long Run," Journal of Applied Econometrics, John Wiley & Sons, Ltd., vol. 6(2), pages 153-68, April-Jun.
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  8. Anderson, G J & Blundell, R W, 1982. "Estimation and Hypothesis Testing in Dynamic Singular Equation Systems," Econometrica, Econometric Society, vol. 50(6), pages 1559-71, November.
  9. Ng, S. & Perron, P., 1994. "Unit Root Tests ARMA Models with Data Dependent Methods for the Selection of the Truncation Lag," Cahiers de recherche 9423, Universite de Montreal, Departement de sciences economiques.
  10. Denis Kwiatkowski & Peter C.B. Phillips & Peter Schmidt, 1991. "Testing the Null Hypothesis of Stationarity Against the Alternative of a Unit Root: How Sure Are We That Economic Time Series Have a Unit Root?," Cowles Foundation Discussion Papers 979, Cowles Foundation for Research in Economics, Yale University.
  11. Weale, Martin, 1986. "The Structure of Personal Sector Short-term Asset Holdings," The Manchester School of Economic & Social Studies, University of Manchester, vol. 54(2), pages 141-61, June.
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  13. Stock, James H & Watson, Mark W, 1993. "A Simple Estimator of Cointegrating Vectors in Higher Order Integrated Systems," Econometrica, Econometric Society, vol. 61(4), pages 783-820, July.
  14. Phillips, Peter C B & Loretan, Mico, 1991. "Estimating Long-run Economic Equilibria," Review of Economic Studies, Wiley Blackwell, vol. 58(3), pages 407-36, May.
  15. Lawrence J. Christiano & Martin Eichenbaum, 1992. "Liquidity effects and the monetary transmission mechanism," Staff Report 150, Federal Reserve Bank of Minneapolis.
  16. John V. Duca, 1993. "Should bond funds be included in M2?," Research Paper 9321, Federal Reserve Bank of Dallas.
  17. Fuerst, Timothy S., 1992. "Liquidity, loanable funds, and real activity," Journal of Monetary Economics, Elsevier, vol. 29(1), pages 3-24, February.
  18. Deaton, Angus S & Muellbauer, John, 1980. "An Almost Ideal Demand System," American Economic Review, American Economic Association, vol. 70(3), pages 312-26, June.
  19. Patrick I. Mahoney, 1988. "The recent behavior of demand deposits," Federal Reserve Bulletin, Board of Governors of the Federal Reserve System (U.S.), issue Apr, pages 195-208.
  20. Serletis, Apostolos, 1991. "The Demand for Divisia Money in the United States: A Dynamic Flexible Demand System," Journal of Money, Credit and Banking, Blackwell Publishing, vol. 23(1), pages 35-52, February.
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