Understanding Instabilityin Aggregate Money Demand: An Approach based on a Life-Cycle Model of Household Portfolio Choice (Preliminary and Incomplete)

I study a model of portfolio choice over the life-cycle incorporating a transactions need of using monetary assets (MA), …xed costs of participation in non-monetary assets (NMFA) markets, and a realistics ‡uctuation of the return spread (the “opportunity cost”of holding MA). I estimate model parameters to match age pro…les of portfolio positions and market participation in a dataset consisting of cross-sectional observations in 1962, 1983, and 1989. Simulated behavior closely resembles that in the cross-sections, and aggregation shows similarity to the time-series of the aggregate M2M (M2 minus small time deposits) in the data. My approach a¤ords analysis of household and aggregate opportunity cost elasticities of MA at each point in time. While the elasticity of NMFA market participants is constant over time, that of nonparticipants varies moderately with the opportunity cost. Aggregate elasticity ‡uctuated dramatically between 1962 and 1989 following the movement of the opportunity cost. The contribution of the extensive margin of participation accounts for most of this ‡uctuation. Thanks are due especially to George Gayle, Mohitosh Kejriwal, Kevin Mumford, and Gustavo Ventura for helpful conversations; and to Chetan Dave, Dave Dejong, Scott Dressler, John Du¤y, David Hummels, and Seminar participants at the University of Pittsburgh and Purdue University. All remaining errors are my own.