RDP 8403: Modelling Recent Developments in Australian Asset Markets: Some Preliminary Results 2. The Money Market

The deregulation of deposit-taking by banks can be expected to lead to less variation in interest differentials between money (which is predominantly bank deposits) and non-money assets.^[2] Therefore, movements in the own rate of interest on money should, after deregulation, follow movements in other market rates more closely than in the past.

Beginning with the estimated structure of the most recent version of the RBII model,^[3] this is modelled here by revising the definition of the equilibrium money rate, , in equation (19) of RBII to depend on both the bond rate r_b, and the bill rate, r_b1, rather than only on the bond rate. The new specification is:^[4]

It is also desirable that, after deregulation of the own rate on money, the demand for money should be less affected by changes in the general level of interest rates. In the current exercise, it has been assumed that money demand is homogeneous of degree zero in all interest rates (the own rate, and bond and bill rates) together.^[5]

Footnotes

See, for example, Moses (1983), p6. [2]

This is the version described in detail in Fahrer, Rankin and Taylor (1984). [3]

A full listing of the notation and data definitions is given in the Appendix. In the simulations below, β′₆₄ is set to 0.5. [4]

Homogeneity is imposed by reducing the coefficient on the bond rate to be the inverse of the sum of the coefficients on the other two interest rates. [5]