The Case for a Financial Approach to Money Demand

The distribution of money across households is much more similar to the distribution of financial assets than to that of consumption levels. This is a puzzle for theories which directly link money demand to consumption, such as cash-in-advance (CIA), money-in-the-utility function (MIUF) or shopping-time models. This paper shows that the joint distribution of money and financial assets can be explained by an incomplete-market model in which frictions are introduced into financial markets. Money demand is modeled as a portfolio choice with a fixed transaction cost in financial markets.