Money Demand and Macroeconomic Stability Revisited1

Abstract

This paper reexamines the role of money demand for the local dynamics of a sticky price model where money enters the utility function and monetary policy is either conducted according to a Taylor-type interest rate rule or to a Friedman-type constant money growth rule. It is shown that activeness, which is commonly recommended as a device for a stabilizing interest rate policy, leads to stable and unique equilibrium path only if preferences are restricted in a way, which is hardly consistent with the view that money provides transaction services. In particular, the Taylor-principle relies either on the utility function to be separable or on end-of-period money holdings to provide utility. When, however, the beginning-of-period stock of money provides utility, interest rate policy should instead be passive if the utility function is specified in a (non-separable) way, which accords to an explicit specification of transaction services. Macroeconomic stability is, on the contrary, shown to be ensured if the central bank applies a constant money growth rule. JEL classification: E52, E41, E32.

Cite this paper

@inproceedings{Schabert2004MoneyDA, title={Money Demand and Macroeconomic Stability Revisited1}, author={Andreas Schabert and Christian Ditlev Gabriel Stoltenberg}, year={2004} }