Limited Commitment and the Demand for Money

University of Zurich, Department of Economics, Working Paper No. 199

44 Pages Posted: 24 Jul 2015 Last revised: 9 Mar 2016

See all articles by Aleksander Berentsen

Aleksander Berentsen

University of Basel - Faculty of Business and Economics; CESifo (Center for Economic Studies and Ifo Institute)

Samuel Huber

University of Basel

Alessandro Marchesiani

University of Bath - Department of Economics

Date Written: February 19, 2016

Abstract

Understanding money demand is important for our comprehension of macroeconomics and monetary policy. Its instability has made this a challenge. Common explications for the instability are financial regulations and financial innovations that shift the money demand function. We provide a complementary view by showing that a model where borrowers have limited commitment can significantly improve the fit between the theoretical money demand function and the data. Limited commitment can also explain why the ratio of credit to Ml is currently so low, despite that nominal interest rates are at their lowest recorded levels. In a low interest rate environment, incentives to default are high and so credit constraints bind tightly, which depresses credit activities.

Keywords: Money demand, financial intermediation, limited commitment

JEL Classification: D9, E4, E5

Suggested Citation

Berentsen, Aleksander and Huber, Samuel and Marchesiani, Alessandro, Limited Commitment and the Demand for Money (February 19, 2016). University of Zurich, Department of Economics, Working Paper No. 199, Available at SSRN: https://ssrn.com/abstract=2634531 or http://dx.doi.org/10.2139/ssrn.2634531

Aleksander Berentsen (Contact Author)

University of Basel - Faculty of Business and Economics ( email )

Petersplatz 1
Basel, 4001
Switzerland

CESifo (Center for Economic Studies and Ifo Institute) ( email )

Poschinger Str. 5
Munich, DE-81679
Germany

Samuel Huber

University of Basel ( email )

Petersplatz 1
Basel, CH-4003
Switzerland

Alessandro Marchesiani

University of Bath - Department of Economics ( email )

Claverton Down
Bath, BA2 7AY
United Kingdom

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