LIMITED COMMITMENT AND THE DEMAND FOR MONEY

Understanding money demand is important for our comprehension of macroeconomics and monetary policy. Its instability has made this a challenge. Common explications for the instability are financial regulations and financial innovations that shift the money demand function. We provide a complementary...

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Bibliographic Details
Published inThe Economic journal (London) Vol. 128; no. 610; pp. 1128 - 1156
Main Authors Berentsen, Aleksander, Huber, Samuel, Marchesiani, Alessandro
Format Journal Article
LanguageEnglish
Published Oxford John Wiley & Sons Ltd 01.05.2018
Oxford University Press
Subjects
Commitment
Economic models
Economic theory
Inflation
Innovations
Interest rates
Macroeconomics
Monetary policy
Money demand
Money supply
Regulation of financial institutions
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Summary:Understanding money demand is important for our comprehension of macroeconomics and monetary policy. Its instability has made this a challenge. Common explications for the instability are financial regulations and financial innovations that shift the money demand function. We provide a complementary view by showing that a model where borrowers have limited commitment can significantly improve the fit between the theoretical money demand function and the data. Limited commitment can also explain why the ratio of credit to M1 is currently so low, despite that nominal interest rates are at their lowest recorded levels.
Bibliography:We thank the editor and two anonymous referees for very helpful comments. We also thank seminar participants at the 2016 Annual Meeting of the Society for Economic Dynamics, Toulouse (France), the 2016 Bank of France conference about liquidity, market frictions, and the economy, Paris and the Spring 2016 Midwest Macro Meetings, Purdue University. The views expressed in this article are those of the authors and not necessarily those of the Federal Reserve Bank of St. Louis, the Federal Reserve System, or the FOMC. Any remaining errors are the authors’ responsibility.
ISSN:0013-0133
1468-0297
DOI:10.1111/ecoj.12449