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Demand for Money and the Interest Rate in Sweden Since 1987

June 27, 2012

Demand for money (M) is thought to be equal to GDP (current prices) times a function (L) which depends on the interest rate.

A higher interest rate should imply less demand for money — the cost of borrowing goes up and the payoff from a savings account is higher — so we would expect the relationship between money and the interest rate to be negative. (See Blanchard)

If equilibrium in financial markets is assumed, then money demand is equal to money supply.

The following graph plot the left-hand side together with the right-hand side of the (second) equation for Sweden since 1987. Money supply is measured by M3 and the interest rate is an average of 2Y, 5Y and 7Y government bonds.

Sources: Statistics Sweden, The Riksbank (of Sweden)

It can be seen that the expected negative relationship do in fact hold. Since the eighties the trend has been a higher ratio of money and a corresponding lower interest rate.

If instead yearly changes are displayed, a similar (however somewhat weaker) pattern appears:

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From → Economics, Finance

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