Abstract
The IMF Working Papers series is designed to make IMF staff research available to a wide audience. Almost 300 Working Papers are released each year, covering a wide range of theoretical and analytical topics, including balance of payments, monetary and fiscal issues, global liquidity, and national and international economic developments.
Many studies of the demand for money, covering a wide variety of economies, have demonstrated the importance of financial innovations and shifts in monetary policy regimes, but they have also illustrated the difficulty of measuring and assessing such changes. Because innovations and regime shifts have differed markedly across countries, international comparisons can help identify their effects. This paper reviews the literature on money-demand comparisons, focusing primarily on industrial countries. It finds that innovations and regime shifts have had widespread effects, notably on the trend rate of growth of real balances, but also that the demand for money is generally no less stable now than it was before those changes occurred.
In the past few years, reasonably stable money-demand equations have been estimated for all of the major industrial countries, with residual errors that have not risen significantly with the inclusion of data from the 1980s. Even so, these equations are all more complex than those estimated earlier, at least in the dynamics but often in the equilibrium relationships as well. From a policy perspective, the central problem facing researchers is to identify the factors that have been driving changes in the demand for money and to determine whether those are ongoing influences or discrete shifts in behavior.
In addition to financial innovations and regime shifts, there are four general factors that may have been important determinants of changes in money demand or velocity in one or more of the major countries. First, shifts in inflationary expectations caused money demand to drop in the 1970s and then to rise sharply again when inflation abated in the 1980s. Second, open economy considerations such as expected exchange rate changes may have induced some portfolio shifting between national moneys, although the available literature has not revealed pervasive effects. Third, to the extent that income elasticities of the demand for money have differed from unity, velocity has become more volatile, reflecting the greater volatility of output in recent years. And fourth, because a substantial portion of money balances (broadly defined) now pays a short-term market rate of interest, shifts in the term structure of interest rates have, in some cases, generated significant shifts in the demand for money. Nonetheless, the evidence does not suggest that the volatility of money holdings was generally higher in the 1980s than it was in the 1960s.