The Demand for Money in a Stochastic Environment

Joseph Atta-Mensah

Staff Working Papers from Bank of Canada

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.

Keywords: Monetary; aggregates (search for similar items in EconPapers)
JEL-codes: E41 E50 G11 (search for similar items in EconPapers)
Pages: 29 pages
Date: 2004
New Economics Papers: this item is included in nep-mac and nep-mon
References: View references in EconPapers View complete reference list from CitEc
Citations: View citations in EconPapers (3)

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