Functional equivalence between liquidity costs and the utility of money

RC Feenstra - Journal of Monetary Economics, 1986 - Elsevier
Journal of Monetary Economics, 1986Elsevier
We demonstrate a functional equivalence between using real balances as an argument of
the utility function and entering money into liquidity costs which appear in the budget
constraint. The liquidity costs can be approximately derived from conventional models of
money demand, such as the transactions and precautionary models. We also propose a
general class of liquidity cost functions and show an exact duality between it and a broad
class of utility functions which include real balances. There is a tendency for the cross …
Abstract
We demonstrate a functional equivalence between using real balances as an argument of the utility function and entering money into liquidity costs which appear in the budget constraint. The liquidity costs can be approximately derived from conventional models of money demand, such as the transactions and precautionary models. We also propose a general class of liquidity cost functions and show an exact duality between it and a broad class of utility functions which include real balances. There is a tendency for the cross-derivative between real balances and the consumption good to be non-negative, though this result will not hold for utility functions which are sufficiently concave.
Elsevier
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