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The Demand for Money at the Zero Interest Rate Bound

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  • Tsutomu Watanabe

    (Graduate School of Economics,University of Tokyo)

  • Tomoyoshi Yabu

    (Faculty of Business and Commerce, Keio University)

Abstract

This paper estimates a money demand function using US data from 1980 onward, including the period of near-zero interest rates following the global financial crisis. We conduct cointegration tests to show that the substantial increase in the money-income ratio during the period of near-zero interest rates is captured well by the money demand function in log-log form, but not by that in semi-log form. Our result is the opposite of the result obtained by Ireland (2009), who, using data up until 2006, found that the semi-log specification performs better. The difference in the result from Ireland (2009) mainly stems from the difference in the observation period employed: our observation period contains 24 quarters with interest rates below 1 percent, while Ireland’s (2009) observation period contains only three quarters. We also compute the welfare cost of inflation based on the estimated money demand function to find that it is very small: the welfare cost of 2 percent inflation is only 0.04 percent of national income, which is of a similar magnitude as the estimate obtained by Ireland (2009) but much smaller than the estimate by Lucas (2000).

Suggested Citation

  • Tsutomu Watanabe & Tomoyoshi Yabu, 2018. "The Demand for Money at the Zero Interest Rate Bound," Working Papers on Central Bank Communication 002, University of Tokyo, Graduate School of Economics.
  • Handle: RePEc:upd:utmpwp:002
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    References listed on IDEAS

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    Cited by:

    1. Tsutomu Watanabe & Tomoyoshi Yabu, 2019. "How Large is the Demand for Money at the ZLB? Evidence from Japan," Working Papers on Central Bank Communication 013, University of Tokyo, Graduate School of Economics.
    2. Tsutomu Watanabe, 2020. "The Welfare Implications of Massive Money Injection: The Japanese Experience from 2013 to 2020," CARF F-Series CARF-F-493, Center for Advanced Research in Finance, Faculty of Economics, The University of Tokyo.
    3. Saito, Makoto & 齊藤, 誠, 2020. "Long-run mild deflation under fiscal unsustainability in Japan," Discussion Paper Series 703, Institute of Economic Research, Hitotsubashi University.
    4. Tsutomu Watanabe, 2021. "The Welfare Implications of Massive Money Injection: The Japanese Experience from 2013 to 2020," Asian Economic Policy Review, Japan Center for Economic Research, vol. 16(2), pages 224-242, July.
    5. Tsutomu Watanabe, 2020. "The Welfare Implications of Massive Money Injection: The Japanese Experience from 2013 to 2020," Working Papers on Central Bank Communication 028, University of Tokyo, Graduate School of Economics.

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    More about this item

    Keywords

    money demand function; cointegration; zero lower bound; near-zero interest rates; welfare cost of inflation; log-log form; semi-log form; interest elasticity of money demand;
    All these keywords.

    JEL classification:

    • C22 - Mathematical and Quantitative Methods - - Single Equation Models; Single Variables - - - Time-Series Models; Dynamic Quantile Regressions; Dynamic Treatment Effect Models; Diffusion Processes
    • C52 - Mathematical and Quantitative Methods - - Econometric Modeling - - - Model Evaluation, Validation, and Selection
    • E31 - Macroeconomics and Monetary Economics - - Prices, Business Fluctuations, and Cycles - - - Price Level; Inflation; Deflation
    • E41 - Macroeconomics and Monetary Economics - - Money and Interest Rates - - - Demand for Money
    • E43 - Macroeconomics and Monetary Economics - - Money and Interest Rates - - - Interest Rates: Determination, Term Structure, and Effects
    • E52 - Macroeconomics and Monetary Economics - - Monetary Policy, Central Banking, and the Supply of Money and Credit - - - Monetary Policy

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