Working Paper: CEPR ID: DP6812
Authors: Javier Andrés; J. David López-Salido; Edward Nelson
Abstract: We examine the role of money in three environments: the New Keynesian model with separable utility and static money demand; a nonseparable utility variant with habit formation; and a version with adjustment costs for holding real balances. The last two variants imply forward-looking behaviour of real money balances, with forecasts of future interest rates entering current portfolio decisions. We conduct a structural econometric analysis of the U.S. and euro area economies. FIML estimates confirm the forward-looking character of money demand. A consequence is that real money balances are valuable in anticipating future variations in the natural interest rate.
Keywords: money; natural rate; New Keynesian models
JEL Codes: E51; E52
Edges that are evidenced by causal inference methods are in orange, and the rest are in light blue.
| Cause | Effect |
|---|---|
| money demand (E41) | natural interest rate (E43) |
| real money balances (E41) | natural interest rate (E43) |
| forward-looking money demand (E41) | natural interest rate (E43) |
| money demand (E41) | transmission mechanism of monetary policy (E52) |
| real money balances (forward-looking) (E41) | natural interest rate (E43) |