Money Demand in General Equilibrium Endogenous Growth: Estimating the Role of a Variable Interest Elasticity

The paper presents and tests a theory of the demand for money that is derived from a general equilibrium, endogenous growth economy, which in e¤ect combines a special case of the shopping time exchange economy with the cash-in-advance framework. The model predicts that both higher in‡ation and …nancial innovation that reduces the cost of credit induce agents to substitute away from money towards exchange credit. The implied interest elasticity of money demand rises with the in‡ation rate and …nancial innovation rather than being constant as is typical in shopping time speci…cations. Using quarterly data for the US and Australia, we …nd evidence of cointegration for the money demand model. This money demand stability results because of the extra series that capture …nancial innovation; included are robustness checks and comparison to a standard money demand speci…cation. Revised September 2006: We thank Bruce Felmingham, Eva-Ulrike Fieber, Lance Fisher, Geo¤rey Kingston, By Jeong, Michal Kejak, Jan Kmenta, Adrian Pagan, Andreas Schabert, Graham Voss and seminar participants at Australian National University, CERGE-EI of Prague, the University of New South Wales, University of Melbourne, the Third Macroeconomics Workshop at the University of Tasmania, the EEA Annual Meetings at Toulouse, the National Bank of Hungary, and the Monetary Economics Workshop HWWA Hamburg, for helpful comments; earlier version: HWWA Discussion Paper 254.