Demand for M2 at the Zero Lower Bound: The Recent U.S. Experience

43 Pages Posted: 2 Apr 2014

See all articles by Ruth Judson

Ruth Judson

Board of Governors of the Federal Reserve - Division of International Finance

Bernd Schlusche

Board of Governors of the Federal Reserve System

Vivian Wong

Board of Governors of the Federal Reserve System

Multiple version iconThere are 2 versions of this paper

Date Written: January 24, 2014

Abstract

In this paper, we re-examine the relationship between money and interest rates with a focus on the past few years, when the opportunity cost of M2 has dropped below zero. Until the late 1980s, a stable relationship between monetary aggregates and the opportunity cost of holding money -- measured as the spread between the three-month Treasury bill yield and the deposit-weighted average return on M2 assets -- existed, and played an integral role in the conduct of monetary policy (e.g., Moore et al.(1990)). This relationship broke down in the early 1990s, when M2 velocity increased beyond the range that could be explained by movements in M2 opportunity cost. As of the mid-2000s, a new relationship was emerging, but was still statistically unstable. In late 2008, the opportunity cost of holding money dropped precipitously and has remained at its zero lower bound. Standard money-demand theory indicates that in such cases the interest elasticity of money demand should rise sharply.

Reviewing the evidence to date, we fail to find support for such a rise through 2011, but we observe a notable change in the relationship over the most recent quarters. We conjecture that the more recent shifts, however, could be due to the effects of regulatory and monetary policy changes rather than a fundamental shift in the relationship between money and opportunity cost. Further work is needed to determine the contribution of these regulatory and monetary policy factors.

Keywords: money demand, M2, zero lower bound, opportunity cost

JEL Classification: E4, E41, E43, E47

Suggested Citation

Judson, Ruth A. and Schlusche, Bernd and Wong, Vivian, Demand for M2 at the Zero Lower Bound: The Recent U.S. Experience (January 24, 2014). FEDS Working Paper No. 2014-22. Available at SSRN: https://ssrn.com/abstract=2418329 or http://dx.doi.org/10.2139/ssrn.2418329

Ruth A. Judson

Board of Governors of the Federal Reserve - Division of International Finance ( email )

20th and C Streets, NW
Washington, DC 20551
United States

Bernd Schlusche (Contact Author)

Board of Governors of the Federal Reserve System ( email )

20th Street and Constitution Avenue NW
Washington, DC 20551
United States

Vivian Wong

Board of Governors of the Federal Reserve System ( email )

20th Street and Constitution Avenue NW
Washington, DC 20551
United States

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