The Relationship of Opportunity Cost to the Interest Elasticity of Money Demand

Abstract

This paper examines the impact of changing opportunity costs on the money demand relation proposed by Friedman and Schwartz (1982). The Friedman-Schwartz relation is estimated across regimes that alternately have permitted and prohibited interest payments on demand accounts. Extending the Friedman-Schwartz analysis to include the monetary base and M1, the effects of differing opportunity costs on money demand are examined through time. It is the introduction of interest bearing accounts into Ml that has changed the opportunity cost of holding (demanding) Ml relative to the alternatives, causing the apparent instability in the velocity of Ml.Monetary; Money Demand; Money