The impact of uncertainty on money demand in the UK, US and Euro area

Abstract

We estimate money demand functions for the UK, the Euro area and the US using Divisia monetary aggregates and investigate the extent to which the uncertainty caused by Brexit and Covid have affected these relationships. Our cointegrated VAR analysis shows that for all three economies Brexit and/or Covid have had some impact on the stability of money demand functions. We find that including a measure of stock market volatility in the money demand specifications helps re-establish stability of the models, particularly for the UK and the Euro area. We also explore the uncertainty and money demand relationship in the context of a Markov-switching model. We find that the effect of uncertainty on the demand for money is more pronounced during periods of heightened uncertainty. The findings of this study lend support to studies calling for Divisia aggregates to be given a more prominent role in policymaking, especially when interest rates are in the zero lower bound environment and are less informative about the stance of monetary policy.

KEYWORDS:

• Money demand
• Divisia
• uncertainty
• Markov switching VAR

JEL CLASSIFICATIONS:

• C32
• E41
• E44

Acknowledgements

We are very grateful to Barry Jones at Binghamton University, SUNY, for providing data on Divisia monetary aggregates and their associated user costs for the UK and the Euro area. Also, we are very grateful to Ryan Mattson at the Center for Financial Stability, New York for providing the Divisia and user cost data for the USA. We are also thank three anonymous reviewers, whose helpful comments have helped us to improve this paper substantially.

Disclosure statement

No potential conflict of interest was reported by the author(s).

Notes

1 https://www.policyuncertainty.com/about.html.

2 It is worth noting that, in order to maintain our degrees of freedom, our results regarding the various effects are symmetric (for example, a increase or decline of the uncertainty growth for each regime would have the same effects in absolute magnitude on the money growth albeit with different signs). Future studies may relax this assumption.

3 The restricted variables take their actual values for a specified period but appear as zero elsewhere.

Additional information

Notes on contributors

Rakesh K. Bissoondeeal

Rakesh K. Bissoondeeal is a Senior Lecturer in Economics and Finance at Aston University.

Jane M. Binner

Jane M. Binner joined the Accounting and Finance Department at Birmingham Business School as Chair of Finance in 2013. Prior to this she worked as Head of the Accounting and Finance Division at Sheffield Management School and as Reader in Economics at Aston Business School for 7 years. Jane has a PhD, MSc, PGCE and BA Hons in Economics from the University of Leeds. She has worked with a number of stakeholder groups such as the Home Office, Experian, the Boots Group plc and Wright Patterson Airforce Base. Jane Binner brings expertise in analyzing the strategic investment decisions of large enterprises through econometric modelling and has extensive academic and commercial experience. She has achieved international recognition for her work on the econometric performance of monetary aggregates and is world leading in her field of financial innovation in the construction of money. She is an INDI Fellow at the Institute for Nonlinear Dynamical Inference and has four books and over seventy publications in the area of Computational Finance and Economics.

Michail Karoglou

Michail Karoglou is a Senior Lecturer in Economics and Finance at Aston University.