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Precautionary demand for money in a monetary business cycle model

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52 pages

We investigate quantitative implications of precautionary demand for money for business cycle dynamics of velocity and other nominal aggregates. Accounting for such dynamics is a standing challenge in monetary macroeconomics: standard business cycle models that have incorporated money have failed to generate realistic predictions in this regard. In those models, the only uncertainty affecting money demand is aggregate. We investigate a model with uninsurable idiosyncratic uncertainty about liquidity need and find that the resulting precautionary motive for holding money produces substantial qualitative and quantitative improvements in accounting for business cycle behavior of nominal variables, at no cost to real variables.
Visschers acknowledges SFU's President's Research Grant, UC3M's Instituto de Economía, a Spanish Ministry of Science Grant and a grant from the Juan de la Cierva Program.
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Working Paper 11-42 Departamento de Economía
Economic Series Universidad Carlos III de Madrid
November, 2011 Calle Madrid, 126
28903 Getafe (Spain)
Fax (34) 916249875


Precautionary Demand for Money in a Monetary Business
*
Cycle Model


Irina A. Telyukova Ludo Visschers
University of California, San Diego Universidad Carlos III de Madrid


First version: June 2008
This version: November 2011


Abstract

We investigate quantitative implications of precautionary demand for money for business cycle
dynamics of velocity and other nominal aggregates. Accounting for such dynamics is a standing challenge
in monetary macroeconomics: standard business cycle models that have incorporated money have failed
to generate realistic predictions in this regard. In those models, the only uncertainty affecting money
demand is aggregate. We investigate a model with uninsurable idiosyncratic uncertainty about liquidity
need and find that the resulting precautionary motive for holding money produces substantial qualitative
and quantitative improvements in accounting for business cycle behavior of nominal variables, at no cost
to real variables.




* For helpful comments, we thank Alexander Wolman and an anonymous referee, as well as Jonathan Chiu, Makoto Nakajima, Fernando
Alvarez, Manuel Amador, Paul Beaudry, Miquel Faig, Bel_en Jerez, Allen Head, Amartya Lahiri, Fernando Martin, Martin Schneider and
Shouyong Shi as well as seminar participants at UCLA, UCSD, UC Irvine, UC Riverside, Stanford, U. Carlos III Madrid, U. of Chicago, UBC,
SFU, Zürich, Leicester and conference participants at EERTEC Florence, 2009 Philadelphia Fed Workshop on Monetary and Macroeconomics,
LAEF Payments and Networks Conference at UCSB, CMSG Annual Meetings 2008, Chicago Fed Summer Workshop on Money, Banking and
Payments, NES Moscow and IHS Vienna. We completed a previous version of this paper while visiting the Einaudi Institute for Economics and
Finance. Visschers acknowledges SFU's President's Research Grant, UC3M's Instituto de Economía, a Spanish Ministry of Science Grant and a
grant from the Juan de la Cierva Program. c 2011 I. A. Telyukova and L. Visschers 1 Introduction
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