The Effect of Mortgage Refinancing on Money Demand and the Monetary Aggregates

ll~tONEY SERVES AS A medium of exchange for transactions involving financial instruments as well as real goods and services. Unfortunately, the total volume of tt-ansactions iti the economy is not observable. As a result, economic analyses of rnomiev demand typically focus on the t-elationship between the quantity of money demanded and the production of new goods and services, measured by either gross domestic product or personal consumption expenditures. Because aggregate volumes of financial and nonfinancial transactions likely move in par~tllelwith the output of new goods and services, the use of output rather than the volume of transactions may cost little in terms of understanding movements in the monetary aggregates. In some periods, however, events occur which remind us that this is not always the case. This article examnines the effect of one such ongoimig recent event— the refinancimtg of residential mortgages— on money demand.’ Simple models of the demand for money as a medium of exchange often implicitly assume that the purchase or sale of a good or service is completed within a relatively brief period. Unlike the transactiomis in these models, the refinancing of a r’esidential mortgage that has been securitized in the secondary market initiates a sequence of transactions that may continue for four to six weeks, or niore. During this time, the quantity of liquid deposits demanded increases. When the last transactiomi in the sequence is concluded, the quantity of deposits demanded falls back ceterus paribas to its earlier level. Mortgage refinancing is an important phenome-