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Time-Varying Money Demand and Real Balance Effects

Jonathan Benchimol () and Irfan Qureshi

No 364, Globalization Institute Working Papers from Federal Reserve Bank of Dallas

Abstract: This paper presents an analysis of the stimulants and consequences of money demand dynamics. By assuming that households’ money holdings and consumption preferences are not separable, we demonstrate that the interest-elasticity of demand for money is a function of the households’ preference to hold real balances, the extent to which these preferences are not separable in consumption and real balances, and trend inflation. An empirical study of U.S. data revealed that there was a gradual fall in the interest-elasticity of money demand of approximately one-third during the 1970s due to high trend inflation. A further decline in the interest-elasticity of the demand for money was observed in the 1980s due to the changing household preferences that emerged in response to financial innovation. These developments led to a reduction in the welfare cost of inflation that subsequently explains the rise in monetary neutrality observed in the data.

Keywords: Time-Varying Money Demand; Real Balance Effect; Welfare Cost of Inflation; Monetary Neutrality (search for similar items in EconPapers)
JEL-codes: E31 E41 E52 (search for similar items in EconPapers)
Date: 2019-06-11
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DOI: 10.24149/gwp364

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