Question

What evidence is used to assess the stability of the money demand function? What does the evidence suggest about the stability of money demand, and how has this conclusion affected monetary policymaking?

Short answer

The velocity indicator has been used to detect if the economy is stable or not. If the velocity component is stable, so is the financial sector, and vice versa. The Federal Reserve switched from using the money supply just like its primary policy measure to using interest rates just like its key monetary policy signal.

Step-by-step solution

Step 1. Define demand.

The quantity of a good that buyers are willing and able to acquire at various prices over a certain time period is referred to as demand.

Step 2. Explanation

The velocity indicator has been used to detect if the economy is stable or not. If the velocity component is stable, so is the financial sector, and vice versa.

The financial sector remained constant until the mid-1970s, when financial innovation caused velocity to become more unpredictable, indicating a more volatile money demand function.

The Federal Reserve switched from using the money supply just like its primary policy measure to using interest rates just like its key monetary policy signal.