Unstable Velocity, Volatile Exchange Rates, And Currency Substitution: The Demand For Money In A Multicurrency World

The thesis examines the problem of recent instability in the demand for money functions of the major OECD economies. Several clues in the literature lead to consideration of currency substitution, the presumption being that recent increases in the latter have resulted in unexpected exhange rate volatility as well as shifts in the world demand for money equations. The Thesis investigates the microeconomic foundations of the demand for money in a world where transactions occur in more than one currency, and where portfolios include foreign currency deposits. Three distinct but complementary theories are developed, each based on one of the three Keynesian motives for holding money: the transactions, precautionary and speculative motives. A variety of testable, discriminating hypotheses are derived.;The Thesis tests the predictions for both narrow and broad definitions of the money stock, for two alternative adjustment specifications of the demand for money, using data for Canada, the United States, and Germany. While the results for the popular \u27partial-adjustment\u27 model are largely negative, those for a \u27polynominal distributed lag\u27 model are supportive of the hypotheses derived in the theoretical chapters. In particular, expected rates of depreciation, foreign interest rates and foreign income are jointly statistically significant at the 0.95 level, indicating that a significant proportion of the variation in the demand for real cash balances may be explained by \u27currency substitution\u27.;Subsequently, the reliability of the demand for money specifications which take account of foreign influences is compared with that of traditional, \u27one-money\u27 equations, by conducting ex-post forecasting experiments. It is found that the traditional specification performs best for Canada, while the expanded specification, which incorporates the hypotheses of this Thesis, achieves a lower root-mean-squared forecast error for both Germany and the United States