Money is used in three different ways: as a means for exchange, a unit of account, and a store of value. When people spend money, they demand money more. When they save money, they demand money less. This can lead people to think that the demand for money is dependent on interest rates, since interest rates are high when people spend money and low when they save. However, interest rate changes do not shift money demand. What causes money demand to shift, then? An increase in income and an increase in government spending on goods and services leads to an increase in the demand for money. Despite interest rates not being the cause of the shifting of money demand, there is a large impact on interest rates as the demand for money shifts. At the equilibrium interest rate (when money supply = money demand), people shift to saving money, which decreases the demand for money. Saving leads to a decrease in the interest rate. Increases in the interest rate is due to an increase in money demanded and a decrease in money supplied. With this information, we can conclude that the interest rate reacts to a change in the demand/supply for money, not the other way around. Further, we can assume that monetary policy does not impact interest rates, but rather the demand for money. When the Fed implements a policy with the goal of changing interest rates, they are actually changing the demand for money.
The Uncertainty Avoidance Index (UAI) is a tool used to rate people in a society’s tendency to feel uncomfortable with uncertainty and ambiguity. The UAI ranks the Japanese as one of the highest uncertainty avoidant people. In its attempt to test out the new Monetary Policy Uncertainty index (MPU), the Journal of the Asia Pacific Economy investigated Japan’s uncertainty in monetary policy and its effect on their demand for money. The study found that “The Japanese demand more money when the uncertainties in monetary policy (MPU) fall and they demand less money when the MPU rises. Therefore, rising uncertainties in monetary policy keep the Japanese away from demanding their domestic currency, YEN” (Ongan, Gocer, 2021). The uncertainty the Japanese have in monetary policy is affecting their interest rates as well. A change in monetary policy means a change in the demand for money. In Japan’s case, uncertainty avoidance leads to a decreased demand for money, which decreases interest rates.
Another factor that can shift the demand of money is how volatile money is. Volatility in this sense means how much cash is being transferred from one person to another. So, more money being spent raises the volatility of money whereas less money being spent leads to a lower volatility. What can make people want to not spend money? One huge example in today's society is the effects of Coronavirus. Murad Antia, a writer for the Tampa Bay Times, said, “Volatility has declined from a high of about 2.2 in the 1990s to a bit below 1.5 before COVID-19, and to 1.1 during the pandemic” (Antia). The reason volatility shot down during the pandemic was people were uncertain about the future causing them to be more cautious with their money. Also, there are numerous other reasons that would cause people to save like trying to create a savings account or there's no need to spend due to the amount of wealth they have already accumulated. So, what does this do to the money demand? As money becomes less volatile the demand of money shifts down (left on graph) which we have seen in the previous year.
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