Policy Uncertainty and the demand for money in Australia: An asymmetry analysis

Abstract

Previous research has considered the impacts of both monetary and output uncertainty on the demand for money in Australia using a linear model and found that while output volatility has significantly positive effects, money supply volatility does not. Furthermore, the predictive power of the linear model was very low. In this paper, we use a nonlinear model and a new measure of uncertainty known as policy uncertainty and show that this new measure has significantly long‐run asymmetric effects on the demand for money in Australia. Due to the nonlinear adjustment of policy uncertainty measure, the new nonlinear model has a very high predictive power. The adjusted R2 moves from 0.30 in the linear model to 0.80 in the nonlinear model.