Teles and Zhou:

- Definitions:
1) Relationship between real money, a nomial interest rate and measure of
economic activity is called money demand relationship.
2) M1: Currency held by public, Demand Deposits, Checkable deposits,
Traveler Checks

M2: M1 + Savings deposits + money market deposit accounts (MMDA) +

Small denomination time deposits + Retail money market Mutual Funds

M3: M2 + Institutional Money Market Funds + Large denomination time

deposits + Eurodollars + Repos

MZM (Money zero maturity): M2 small denomination time deposits +

Institutional Money Market mutual funds.

- Main Theme:

Lucas (1988) showed that money demand relationship is stable (with unitary
income elasticity) i.e. we can reliably answer questions such as how money
demand changes in response to nominal rates. In his framework nominal
interest rates are thought of as a measure of the opportunity cost of money.
His study uses the monetary aggregate M1 (the most liquid) as the measure
of money. This relationship only holds well till mid-80s.

During the 80s and the 90s interest rates were low and this suggests that in
response growth of M1 should have been substantial. The actual growth rate,
however, was low and inconsistent with the theory. One reason that has been
suggested in literature is that the money demand relationship is not stable at
all.

This paper argues that technological innovation and changes in regulatory

practices have made other monetary aggregates as liquid as M1 and so the
measure of money should be adjusted accordingly. They propose using MZM
monetary aggregate and show that that with this measure the stability of
money demand is recovered. The growth in MZM aggregate matches well
with the data and what M1s growth should have been according to theory.

- Adjustment to previous model:

The previous model is based on the M1 monetary aggregate. M1, consisting

of currency, non-interest-bearing demand deposits, and a very small amount
of interest-bearing checkable deposits was the primary transaction monetary
aggregate. The main components of M2, other than M1, were savings
deposits, mostly passbook savings accounts on which checks could not be
written, and small time deposits. Neither could be directly used for
transactions.
 Introduction of electronic payment systems (ACH), interest bearing checking
accounts, checking privileges on savings account and changes in banking
regulation blurred the lines between M1 and M2. A key change that happened
was that transaction money may now earn interest.

The authors suggest an alternate model where they allow money to earn
interest. They suggest using the MZM monetary aggregate to account for
increased usage of M2 in transactions. They find that the model fits the data
well with these adjustments.

Lucas and Nicolini

- After the financial crisis a broad consensus was reached that no measure of
liquidity in an economy was of any value in conducting monetary policy.
The main reason behind this consensus was that empirical relation
connecting monetary aggregates such as M2 and M2 to prices and interest
rates began to deteriorate in 1980s. This paper explores this empirical
breakdown and proposes a fix by constructing a new monetary aggregate
that offers unified treatment of monetary facts before and after 1980.
- The paper adapts the Freeman and Kydland model that studies cash and
demand deposits and adds money market deposit accounts (MMDA) to the
analysis. They do this to account for the increasing relevance of MMDAs as
means of payment. The model helps rationalize the new monetary aggregate
proposed in the paper called NewM1, which essentially is old M1 plus MMDAs.
- The base model helps in three main ways:
1) Decentralizing the model gives a model of competitive banking firms.
2) Using data it can be shown that that the model predictions match the
behavior of the aggregate NewM1 for the entire period (1983-2012)/
3) The decentralized model helps analyze the impact of Regulation Q i.e.
explicit prohibition of interest payments on bank deposits by explicitly
imposing on the base model the condition that payments on deposits are
zero (note we need decentralized because this is a distortion). This
regulation was enforced in the US economy from 1936-1982.
- Key Features of the base model:
1) Households have a unit of labor that is divided between production and
cash management.
2) Households must buy goods from other households and sell what it
produces to others.
3) Households choose the n the number of trips to the bank that they make
in a period.
4) We can think of the n as dividing a period into sub-periods. At the start
of a period the household dollars are split into currency, demand deposits
and MMDAs. At the first sub-period the household spends cash and
deposits on consumption goods and produces goods and collects payment
for their production goods in the forms of cash and checks. At the end of
the sub-period household visits the banks and all their dollars are again
 divided between currency, demand deposits and MMDAs, so that each
sub-period replicates the situation of the initial sub-period.
5) Money is subject to theft loss. Deposit accounts are secure from losses.
MMDAs have a higher labor cash management cost than demand deposits
but demand deposits require a fraction of cash held idle as reserves.
These conditions ensure that in equilibrium all three are held. Just like the
model discussed in class, households also get to choose the thresholds
that determine what sizes of goods are paid for by cash, demand deposits
and MMDAs (where MMDAs pay for the largest sizes).
6) Monetary growth is assumed constant.
- A decentralized version of the model with a ceiling 0 on the rate banks can
pay on deposits is used to analyze Q Regulation. The idea is that since banks
are unable to pay interest on deposits, they will compete by reducing check
processing fee.
- The Q Regulation analysis matches the data by giving the correct qualitative
result that under this regulation interest rate elasticity of real balances is high
but the model over predicts this increase and ends up missing the levels of
cash to deposits ratio as observed in the data.