On Transactions and Precautionary Demand For Money

Jacob A. Frenkel and Boyan Jovanovic ()

No 288, NBER Working Papers from National Bureau of Economic Research, Inc

Abstract: This paper develops a stochastic framework for the analysis of transactions and precautionary demand for money. The analysis is based on the principles of inventory managements and the key feature of the model is its stochastic characteristics which lead to the need for precautionary reserves. The formal solution for optimal money holdings is derived and is shown to depend on the rate of interest, the mean rate of net disbursements, the cost of portfolio adjustment and the variance of the stochastic process governing net disbursements. One solution is obtained by minimizing the present value of financial management. This solution is compared with an alternative that is derived from the more conventional methodology of minimizing the steady-state cost function. The comparison shows that the two approaches may yield solutions that differ significantly from each other. The paper concludes with an application of the model to an empirical examination of countries' holdings of international reserves. The empirical results are shown to be consistent with the predictions of the model.

Date: 1978-10
Note: ITI EFG IFM
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Published as Frenkel, Jacob A., and Boyan Jovanovic. "Optimal International Reserves: A Stochastic Framework." The Economic Journal, Vol. 91, (June 1981), pp. 507-514.
Published as Frenkel, Jacob A., and Boyan Jovanovic. "On Transactions and Precautionary Demand for Money," The Quarterly Journal of Economics, MIT Press, vol. 95(1), (August 1980), p. 25-43.

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