Modelling Opportunity Cost Effects in Money Demand due to Openness

Sophie van Huellen, Duo Qin, Shan Lu, Huiwen Wang, Qingchao Wang and Thanos Moraitis
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Shan Lu: School of Economics and Management, Beihang University, China PR.
Huiwen Wang: School of Economics and Management, Beihang University, China PR.
Qingchao Wang: Department of Economics, SOAS University of London, UK
Thanos Moraitis: Department of Economics, SOAS University of London, UK

No 225, Working Papers from Department of Economics, SOAS University of London, UK

Abstract: We apply a novel model-based approach to constructing composite international financial indices (CIFIs) as measures of opportunity cost effects that arise due to openness in money demand models. These indices are tested on the People’s Republic of China (PRC) and Taiwan Province of China (TPC), two economies which differ substantially in size and degree of financial openness. Results show that a) stable money demand equations can be identified if accounting for foreign opportunity costs through CIFIs, b) the monetary policy intervention in the PRC over the global financial crisis period temporarily mitigated disequilibrating foreign shocks to money demand, c) CIFIs capture opportunity costs due to openness more adequately than commonly used US interest rates and d) CIFI construction provides valuable insights into the channels through which foreign financial markets affect domestic money demand.

Keywords: money demand; opportunity cost; open economy (search for similar items in EconPapers)
JEL-codes: C22 E41 F41 O53 (search for similar items in EconPapers)
Pages: 40
Date: 2019-08
New Economics Papers: this item is included in nep-cba, nep-cna, nep-mac, nep-mon, nep-opm and nep-tra
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Persistent link: https://EconPapers.repec.org/RePEc:soa:wpaper:225

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