Working Paper: CEPR ID: DP4337
Authors: Javier Andrés; J. David López-Salido; Edward Nelson
Abstract: In this Paper, we look at the role of money in a general framework that encompasses three competing environments: the New Keynesian model with separable utility and static money demand; the non-separable utility variant with habit formation; and the New Keynesian model modified to allow for adjustment costs for holding real balances. The last two models imply a forward-looking character of real money balances that convey on money an important role as a monetary policy indicator. We distinguish between these alternative views by conducting a structural econometric analysis for the US, the euro area, and the UK. The FIML estimates confirm the forward-looking character of the money demand. Using these estimates we find that, in response to preferences and technology shocks, money incorporates useful information regarding future variations in the natural interest rate.
Keywords: forward-looking; money demand; natural rate of interest
JEL Codes: E52; E58
Edges that are evidenced by causal inference methods are in orange, and the rest are in light blue.
| Cause | Effect |
|---|---|
| forward-looking character of money demand (E41) | information regarding future variations in the natural interest rate (E43) |
| preferences and technology shocks (D11) | real money balances convey significant information about the natural rate (E43) |
| portfolio adjustment costs (G11) | forward-looking behavior of money demand (E41) |
| real money demand with forward-looking element (E41) | value of money as an indicator of future variations in the natural rate (E39) |
| real money fluctuations (F31) | natural rate given other determinants of money demand (E49) |
| model structure (C52) | enhanced understanding of the relationship between money and the natural rate (E49) |
| money (E42) | effective indicator of monetary policy transmission (E52) |