Money Matters: Money 'Demand' is Meaningless

Abstract

Much intellectual energy has been devoted over many decades to the concept of money "demand" and its significance for monetary policy. It is obvious that the non-bank private sector (NBPS) does hold non-interest-bearing money (incongruously called money "demand") for specific purposes (in the main, transactions), but in our view the concept is completely meaningless for monetary policy. Supporters of money "demand" significance exhibit a misunderstanding of the process of money creation and its direct link with the real economy: money creation is the direct outcome of domestic credit extension (DCE) (the raw-data R-squared for the countries tested approaches 1.0), and DCE growth represents nominal GDP growth (because the NBPS borrows to spend) (the raw-data R-squared approaches 1.0). The growth in DCE, in turn, is heavily influenced by the bank lending rate (particularly in real terms, with a lag), which is the target of the only instrument the central bank has: the policy interest rate (PIR) (the other instruments assist in making the PIR effective). Thus, interest rates and GDP are principal arguments in monetary matters, but not in the way portrayed in the money "demand" literature.

Keywords: Money, money creation, money demand, money supply, money and credit, money and output, money and income, central banking, monetary policy

JEL Classification: A22, E42, E51, E52, G21