Money and uncertainty in democratised financial markets

Developments in broad money since the start of the new millennium cannot be explained by the traditional determinants of money demand, namely, income, prices and portfolio effects. Households’ direct and indirect participation in financial markets have led to the widespread democratisation of these markets in the US since the 1970’s. In the pre-democratised era, an increase in uncertainty would have resulted in a fall in the transactions demand for money due to pessimism regarding income and employment prospects. When markets become more democratised, the precautionary, or store-of-value function of money dominates the transactions demand in which case an increase in uncertainty results in a net increase in the demand for money. Our Kalman Filter estimates are consistent with this theory. The money-uncertainty coefficient has been subject to an increasing trend over the whole sample period shifting gradually from significantly negative values up to the mid-to-late-1990s before becoming significantly positive by the early years of the new millennium. There are important repercussions from these new behavioural patterns for both monetary and financial stability which are discussed in this paper.