Mostafa Karimzadeh
Abstract
Money is the one of the most important human innovations that has essential role in facilitating of transactions and economic evolution. Which added its performance with development and complicated of societies. The money market has like all other markets, both a demand side and a supply side. In this ...
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Money is the one of the most important human innovations that has essential role in facilitating of transactions and economic evolution. Which added its performance with development and complicated of societies. The money market has like all other markets, both a demand side and a supply side. In this paper we examine the demand side. Since the 1930s, economists have developed the theory underlying the demand for money along several different lines, each of which provides a different answer to the basic question: If bonds earn interest and money doesn’t, why should a person hold money? While the way the various theories this question differs, in general they come down to a demand for money function.
The cognition of effective factors on money demand is one of the most important economic topics. To answer this problem, some of the economists try to present several money demand theories. In this paper we will evaluate the inventory approach to transaction demand developed by both Baumol and Tobin. They show that there is a transactions need for money to smooth out the difference between income and expenditure streams and the higher the interest rate – the return on holding bonds instead of money – the smaller these transactions demand balances should be.
Theoretical Framework
Keynes had designated the transactions demand for money as due to the transactions motive but had not provided a theory for its determination. In particular, he had assumed that this demand depended linearly on current income but did not depend on interest rates.
Subsequent contributions by Baumol and Tobin in the 1950s established the theory of the transactions demand for money. These contributions showed that this demand depends not only on income but also on the interest rate on bonds. Further, there are economies of scale in money holdings. The transactions demand for money is derived under the assumption of certainty of the yields on bonds, as well as of the amounts and time patterns of income and expenditures.
Baumol (1952) and Tobin (1956) presented their money demand theory by using inventory approach. Developments since the 1950s have extended and broadened the Baumol–Tobin transactions demand analysis, without rejecting it. The most significant extension of this analysis has been to the case where there is uncertainty in the timings of the receipts and payments. The demand for money under this type of uncertainty is usually labeled as the precautionary demand for money. This section presents Baumol’s (1952) version of the inventory analysis of the transactions demand for money. This analysis considers the choice between two assets, “money” and “bonds,” whose discriminating characteristic is that money serves as the medium for payments in the purchase of commodities whereas bonds do not; hence, commodities trade against money, not against bonds. There is no uncertainty in the model, so the yield on bonds is known with certainty. The real-world counterpart of such bonds is interest-paying savings deposits or such riskless short-term financial assets as Treasury bills. Longer-term bonds whose yield is uncertain are not really considered in Baumol’s analysis. Baumol’s other assumptions are:
1. Money holdings do not pay interest. Bond holdings do so at the nominal rate R. There are no own-service costs of holding money or bonds, but there are transfer costs from one to the other, as outlined later. Bonds can be savings deposits or other financial assets.
2. There is no uncertainty even in the timing or amount of the individual’s receipts and expenditures.
3. The individual intends to finance an amount $Y of expenditures, which occur in a steady stream through the given period, and already possesses the funds to meet these expenditures. Since money is the medium of payments in the model, all payments are made in money.
4. The individual intends to cash bonds in lots of $W spaced evenly through the period. For every withdrawal, he incurs a “brokerage (bonds–money transfer) cost” that has two components: a fixed cost of $B0 and a variable cost of B1 per dollar withdrawn. Examples of such brokerage costs are broker’s commission, banking charges and own (or personal) costs in terms of time and convenience for withdrawals from bonds. The overall cost per withdrawal of $W is $(B0 +B1W).
They explained that individuals have two cost about money demand: the cost of interest rate of money (first cost) and the cost of refer to bank (second cost). The most important contribution of their theory is that interest rate influences transactions demand of money.
Results & Discussion
Our paper lead to this occlusion that development of electronic money and banking, causes the Baumol – Tobin theory faces essential critical and challenges. In recent age with development of electronic money and banking, the cost of refer to the bank is very low.
Conclusion & Suggestion
Hence we can assume that this cost is zero. By assumption that the cost of refer to the bank is zero, the inventory theory isn’t appropriate approach to money demand.
mehdi adibpour; Maryam Elhami
Abstract
Introduction
Identification of factors affecting the money demand plays a very important role in the detection of monetary transmission mechanism; and knowing the elasticity of demand for money is vital to guide the monetary policy. The relationship between real money demand and its determinant factors ...
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Introduction
Identification of factors affecting the money demand plays a very important role in the detection of monetary transmission mechanism; and knowing the elasticity of demand for money is vital to guide the monetary policy. The relationship between real money demand and its determinant factors has been at the center of a considerable amount of economic studies during the last decades. Exchange rate is one of the most important factors that has an important effect on many economic variables such as demand for Money. Apart from exchange rate, the variations in exchange rate that cause exchange rate uncertainty also can influence investors' expectations, the preferences of holding financial assets, and the money demand. With regard to the importance of exchange rate uncertainty and its impact on the demad for money, this paper aims to investigate the effects of exchange rate uncertainty on the money demand in Iran over the period of 1988(1) to 2008(4).
Theoretical Framework
The idea that money demand depends on the exchange rate in addition to income and interest rate was first proposed by Mundell (1963). During the last decades, subsequent studies tried to justify the relationship between exchange rate and money demand. Tower and Willett (1976), Al-khuri and Nsoul (1978), Holden, et al. (1979), Cuddington (1983), Bergstrand and Bundt (1990), Bahmani-Osooee and pourheydarian (1990), Leventakis (1993), Chaisrisawatsuk, et al. (2004), Arshad Khan, and Sajjid (2005), Azim, et al. (2010), and Shahadudheen (2011) emphasized on the role of the exchange rate on money demand. In addition to exchange rate, the variations in foreign exchange rate affect composition of optimal money holding. Changes in exchange rate have two effects on the money demand, i.e., wealth effects and substitution effects. Wealth holders ordinarily evaluate their asset in terms of domestic currency. Exchange rate depreciation, for example, would increase the value of their foreign assets held. To maintain a fixed share of their wealth invested in domestic assets, they will repatriate part of their foreign assets to domestic assets, including domestic currency. Hence, exchange rate depreciation would increase the demand for domestic money. On the other hand, exchange rate variations may cause a currency substitution effect, in which investors' expectation plays a crucial role. If wealth holders expect that the exchange rate is likely to fall further following an initial depreciation, they will respond by raising the share of foreign assets. In this condition exchange rate depreciation means higher opportunity cost of holding domestic money. Therefore, currency substitution can be used to hedge against such risk. In this regard, exchange rate depreciation would decrease the demand for domestic money (Sahadudheen, 2012).
Methodology
In this study, money demand has been considered as a function of Gross Domestic Product (GDP) and inflation (to represent the economic activity and the opportunity cost of holding money respectively), real exchange rate and real exchange rate uncertainty. The data used in this study was gathered from central bank of Iran over the period of 1988(1)to 2008(4). To assess the relationship between the series, first, real exchange rate uncertainty was calculated by adopting a Generalized Autoregressive Conditional Heteroskedasticity (GARCH ) model and then was included in the money demand function along with other factors such as Gross Domestic Product, real exchange rate and inflation (as a proxy for interest rate). In the next step, with regards to nonstationary variables, cointegration test was performed to estimate the long run demand for money. Results indicated that there is long run relationship between variables in demand for money model function. Finally, the money demand function was estimated by means of Vector error correction Model (VECM).
Results & Discussion
In this study, we argued that since exchange rate and exchange rate uncertainty have both wealth and substitution effects, they could have a direct impact on the demand for money aside from other variables such as income and inflation. The estimation results from VEC model revealed that income elasticity of money demand (M2) was significant and positive; in the other words, the increase in Gross Domestic Product would increase the money demand. The effect of inflation on money demand was significant and negative. Inflation indicates that the cost of money holding and the increase in it would decrease demand for money. Real exchange rate and real exchange rate uncertainty have had negative and significant effects on money demand that indicates the substitution effect in Iran's economy. In fact, currency substitution effect has been overcomed by the wealth effects.
Conclusion & Suggestions
The negative effects of real exchange rate and its uncertainty on money demand indicates that movement and uncertainty of exchange rate decrease demand for money, which supports the substitution effect. In fact, with the probability of a considerable variation in exchange rate, the opportunity cost of holding money would increase and people prefer to substitute domestic money with foreign currency. For this reason, in order to avoid substantial fluctuations and stabilization of the exchange rate, the adoption of appropriate monetary and foreign exchange policies by the central bank is necessary for Iran's economy.
Sadegh Bafandeh Imandoust; Ghasemie Hesameddin
Abstract
Examination of demand of money and recognition of important factors, is one of the
important problems in macroeconomic. Identifying important factors that can affect
demand money function, beside other economic factors, guaranty successfulness for
economic policies. Semblance of many studies have ...
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Examination of demand of money and recognition of important factors, is one of the
important problems in macroeconomic. Identifying important factors that can affect
demand money function, beside other economic factors, guaranty successfulness for
economic policies. Semblance of many studies have been carried out to specify
factors affecting demand of money, indicate some scattering on choosing important
factors ,so results are different. Lack of knowledge about descriptive variables and
correct model of money demand, produce wrong model.
To avoid a prejudgment on the effective factors of Iran’s money demand (based on a
specific theory), Bayesian Model Averaging is utilized. As it is common, this
approach is based on the estimation of a regression model for many times (here
14,000) and estimation of coefficients with Bayesian Model Averaging. Data period
is between 1976 -2007.
Results show that GNP, CPI (consumer price index), formal exchange rate, ratio of
budget deficit on GNP, lagged dependent variable and CPI with lagged have
significant effects on demand of money.
