The demand for Divisia money

Abstract

A money-in-the-utility function model is extended to capture the distinct roles of noninterest-earning currency and interest-earning deposits in providing liquidity services to households. It implies the existence of a stable money demand relationship that links a Divisia monetary aggregate to spending or income as a scale variable and the associated Divisia user-cost dual as an opportunity cost measure. Cointegrating money demand equations of this form appear in quarterly United States data spanning the period from 1967:1 through 2017:2, especially for the Divisia M2 aggregate. The identification of a stable money demand function over a period that includes the financial innovations of the 1980s and continues through the recent financial crisis and Great Recession suggests that a properly measured aggregate quantity of money can play a role in the conduct of monetary policy. That role can be of greater prominence when traditional interest rate policies are constrained by the zero lower bound.