The Demand for Money at the Zero Interest Rate Bound

Tsutomu Watanabe and Tomoyoshi Yabu
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Tsutomu Watanabe: Graduate School of Economics,University of Tokyo

No 2, Working Papers on Central Bank Communication from University of Tokyo, Graduate School of Economics

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).

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 (search for similar items in EconPapers)
JEL-codes: C22 C52 E31 E41 E43 E52 (search for similar items in EconPapers)
Pages: 30 pages
Date: 2018-09
New Economics Papers: this item is included in nep-cba, nep-mac and nep-mon
References: View references in EconPapers View complete reference list from CitEc
Citations: View citations in EconPapers (6)

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Related works:
Working Paper: The Demand for Money at the Zero Interest Rate Bound (2022)
Working Paper: The Demand for Money at the Zero Interest Rate Bound (2018)
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