Precautionary demand for money in a monetary business cycle model

Telyukova, Irina A. and Visschers, Ludo (2011): Precautionary demand for money in a monetary business cycle model.

Abstract

We investigate quantitative implications of precautionary demand for money for business cycle dynamics of velocity and other nominal aggregates. Accounting for such dynamics is a standing challenge in monetary macroeconomics: standard business cycle models that have incorporated money have failed to generate realistic predictions in this regard. In those models,the only uncertainty aecting money demand is aggregate. We investigate a model with uninsurable idiosyncratic uncertainty about liquidity need and nd that the resulting precautionary motive for holding money produces substantial qualitative and quantitative improvements in accounting for business cycle behavior of nominal variables, at no cost to real variables.

• Item Type: MPRA Paper
• Language: English
• Keywords: precautionary demand for money; business cycle fluctuations; money velocity fluctuations
• Subjects: E - Macroeconomics and Monetary Economics > E3 - Prices, Business Fluctuations, and Cycles > E32 - Business Fluctuations ; Cycles; E - Macroeconomics and Monetary Economics > E4 - Money and Interest Rates > E40 - General; E - Macroeconomics and Monetary Economics > E4 - Money and Interest Rates > E41 - Demand for Money

References

[1] Alvarez, F., A. Atkeson and C. Edmond. 2008. “Sluggish Response of Prices and Inflation to Monetary Shocks in an Inventory Model of Money Demand.” Mimeo, University of Chicago.

[2] Alvarez, F. and F. Lippi. 2009. “Financial Innovation and the Transactions Demand for Cash”. Forthcoming, Econometrica.

[3] Cooley, T. and G. Hansen. 1995. “Money and the Business Cycle”. In Frontiers of Business Cycle Research, Cooley T., ed., Princeton University Press.

[4] Chiu, J. and M. Molico. 2007. “A Search Model of Money with Aggregate and Idiosyncratic Uncertainty”. Mimeo, Bank of Canada.

[5] Cooley, T. and G. Hansen. 1989. “The Inflation Tax in a Real Business Cycle Model”, American Economic Review, 79(4):733-48.

[6] Diamond, D. and P. Dybvig. 1983. “Bank Runs, Deposit Insurance, and Liquidity,” Journal of Political Economy, 91(3): 401-419.

[7] Faig, M. and B. Jerez. 2006. “Precautionary Balances and Velocity of Circulation of Money”, Journal of Money, Credit and Banking, 39(4): 843-873.

[8] Hansen, G. 1985. ”Indivisible Labor and the Business Cycle”, Journal of Monetary Economics, 16(3):309-327.

[9] Hodrick, R., N. Kocherlakota and D. Lucas. 1991. “The Variability of Velocity in Cash-in-Advance Models”, Journal of Political Economy, 99(2): 358-384.

[10] Hagedorn, M. 2008. “A Monetary Model with Strong Liquidity Effects”, mimeo, University of Zuerich.

[11] Keynes, J.M. 1936. “The General Theory of Employment, Interest andMoney”. Prometheus Books, 1997.

[12] Lagos, R. and G. Rocheteau. 2005. “Inflation, Output and Welfare”. International Economic Review, 46(2): 495-522.

[13] Lagos, R. and R. Wright. 2005. “A Unified Framework for Monetary Theory and Policy Analysis”. Journal of Political Economy, 113(3): 463-484.

[14] Levine, D. K. 1991. “Asset Trading Mechanisms and Expansionary Policy”, Journal of Economic Theory, 54(1): 148-164.

[15] Lucas, R. 1980. “Equilibrium in a Pure Currency Economy”. Economic Inquiry, 18: 203-220.

[16] Lucas, R. 2000. “Inflation and welfare”, Econometrica, 68: 247-274.

[17] Lucas, R. and N. Stokey. 1987. “Money and Interest in a Cash-in-Advance Economy,” Econometrica, 55(3): 491-513.

[18] Rocheteau, G. and R. Wright. 2005. “”Money in Search Equilibrium, in Competitive Equilibrium, and in Competitive Search Equilibrium”, Econometrica, 73(1):175-202.

[19] Rogerson, R. 1988. ”Indivisible Labor, Lotteries and Equilibrium”, Journal of Monetary Economics, 21(1):3-16.

[20] Rotemberg, J. and M. Woodford. 1997. “An Optimization-Based Econometric Framework for the Evaluation of Monetary Policy”. NBER Macroeconomics Annual, 12: 297-346.

[21] Shi., S. 1997. “A Divisible Search Model of Fiat Money”, Econometrica, 65(1): 75-102.

[22] Shi., S. 1998. “Search for a Monetary Propagation Mechanism”, Journal of Economic Theory, 81: 314-352.

[23] Tauchen, G., 1986. “Finite State Markov-Chain Approximations to Univariate and Vector Autoregressions”. Economics Letters, 20:177-181.

[24] Telyukova, I.A. 2009. “Household Need for Liquidity and the Credit Card Debt

[25] Telyukova, I.A. and R. Wright 2008. “A Model of Money and Credit, with Application to the Credit Card Debt Puzzle”, Review of Economic Studies, 75(2), 629 - 647.

[26] Temzelides, T. and Yu. 2004. “Lack-Of-Recall And Centralized Monetary Trade”, International Economic Review, 45(4):1221-1227

[27] Wallace, N. 2001. “Whither Monetary Economics?” International Economic Review , 42(4): 847-870.

[28] Wang, W. and S. Shi. 2006. “The Variability of Velocity of Money in a Search Model”, Journal of Monetary Economics, 53: 537-571.

[29] Whalen, Edward L. 1966. “A Rationalization of the Precautionary Demand for Cash.” Quarterly Journal of Economics, 80: 314-25