Precautionary Demand for Money in a Monetary Business Cycle Model

We investigate quantitative implications of precautionary demand for money for business cycle dynamics of velocity and other nominal aggregates. Account-ing for such dynamics is a standing challenge in monetary macroeconomics: standard business cycle models that have incorporated money have failed to generate realistic predictions in this regard. In those models, the only un-certainty affecting money demand is aggregate. We investigate a model with uninsurable idiosyncratic uncertainty about liquidity need and find that the resulting precautionary motive for holding money produces substantial quali-tative and quantitative improvements in accounting for business cycle behavior of nominal variables, at no cost to real variables. ∗For extensive discussions and helpful comments, we thank Jonathan Chiu, Makoto Nakajima