On Transactions and Precautionary Demand for Money

30 Pages Posted: 10 Jul 2000 Last revised: 17 Apr 2021

See all articles by Jacob A. Frenkel

Jacob A. Frenkel

Merrill Lynch & Co. - Sovereign Advisory Group and Global Financial Institutions Group; National Bureau of Economic Research (NBER)

Boyan Jovanovic

New York University - Department of Economics

Date Written: October 1978

Abstract

This paper develops a stochastic framework for the analysis of transactions and precautionary demand for money. The analysis is based on the principles of inventory managements and the key feature of the model is its stochastic characteristics which lead to the need for precautionary reserves. The formal solution for optimal money holdings is derived and is shown to depend on the rate of interest, the mean rate of net disbursements, the cost of portfolio adjustment and the variance of the stochastic process governing net disbursements. One solution is obtained by minimizing the present value of financial management. This solution is compared with an alternative that is derived from the more conventional methodology of minimizing the steady-state cost function. The comparison shows that the two approaches may yield solutions that differ significantly from each other. The paper concludes with an application of the model to an empirical examination of countries' holdings of international reserves. The empirical results are shown to be consistent with the predictions of the model.

Suggested Citation

Frenkel, Jacob A. and Jovanovic, Boyan, On Transactions and Precautionary Demand for Money (October 1978). NBER Working Paper No. w0288, Available at SSRN: https://ssrn.com/abstract=233732

Jacob A. Frenkel (Contact Author)

Merrill Lynch & Co. - Sovereign Advisory Group and Global Financial Institutions Group

New York, NY
United States

National Bureau of Economic Research (NBER)

1050 Massachusetts Avenue
Cambridge, MA 02138
United States

Boyan Jovanovic

New York University - Department of Economics ( email )

19 w 4 st.
New York, NY 10012
United States

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