Estimating Real Money Balance Effect on Private Consumption and Aggregate Demand

Real Money Balance indicates the impact of the changes in real money stock on real variables of the economy. This paper estimates the real money balance effects on private consumption and aggregate demand by using a structural estimation approach. The data that we use is Iran’s annual data and runs from 1990 through 2019. The variables are real private consumption expenditures, M2 money stock, CPI, GDP, population, central bank’s one-year interest rate, the arithmetic mean of growth rates of the price of durable commodities, the exchange rate, the price of gold, and the price of one square meter of land. The estimation shows that the parameter that indicates the importance of the real money balance effect on private consumption is significantly different from zero (0.952 and 0.814 from two different normalization estimations). In addition, the amount of real money balance effect on aggregate demand equals 1.691 which is significantly different from zero. These results indicate the importance of real money balance effects on private consumption and aggregate demand in Iran’s economy. This means that real money influences all macroeconomic variables and has an important role in monetary transaction mechanisms. This result indicates the importance of monetary policy and shows why we cannot ignore money’s role in the monetary transaction mechanism. It also illustrates the negative impacts of price rise in real variables on economics by decreasing real money balance.