| The recent financial changes stemming from spontaneous or induced market developments, regulatory reforms, and changes in the Fed's operating procedures have led to an array of new financial instruments with both transaction and investment characteristics, changing opportunity cost of holding money, blurred distinction between money and other financial assets as well as blurred distinction between commercial banks and other financial intermediaries. Recent years have also witnessed the rapid spread of cash-management techniques, automation of financial industry and increasing reliance on market-determined interest rates. Naturally, these developments have disturbed or altered the relationship between money stock and the economy. An enormous body of literature has thus emerged examining the role of monetary policy in the new financial environment and searching for a stable money demand function. The status of interest elasticity of money demand in the light of these developments, however, has only received incomplete and indirect attention, although its relevance for the slope of the LM curve and the conduct of monetary policy has been well established. The main purpose of this study is to analyze the impact of various developments on the interest elasticity of money demand. Has it increased over time as Gurley and Shaw predicted? What have been the effects of new instruments, such as negotiable order of withdrawal accounts, repurchase agreements and money market mutual funds? How would the interest sensitivities of monetary aggregates compare? Answers to these questions are searched both at theoretical and empirical levels. Although a reduced interest elasticity has been widely predicted, particularly after the Depository Institutions Deregulation and Monetary Control Act of 1980, our findings suggest an increased elasticity of various monetary aggregates with respect to open market rates. However, once the deregulation process is completed and flows of funds among various balances are settled, a lower interest elasticity may still be realized. |
