This paper presents a model on the demand for money market funds (MMFs). These funds are a very close substitute for M1 deposits, except that MMFs do not satisfy immediate transaction requirements. The demand for MMFs strengthens when the intended volume of transactions is low. A high interest rate level makes it expensive to hold M1 deposits. High interest rate volatility, paradoxically, increases the risk of holding M1 deposits stronger than the risk of holding MMFs. The results are largely corroborated by Finnish data.
Introduction: Money market mutual funds (MMFs) invest in nothing but short maturity debt securities, such as treasury bills and certificates of deposit. These funds typically try to avoid default risk and prefer securities issued by low-risk debtors, such as the government. In Euro area monetary statistics these funds are classified as a component of the widest monetary aggregate M3.Investments in Finnish MMFs have skyrocketed in the last few years. In May 2005, these funds as a component of the national contribution to Euro area M3 totalled EUR 11.3 billion, and they accounted for 12% of M3. In January 2000, the stock was just EUR 1.5 billion, about 2% of M3. The average annual growth rate has been almost 50%; it is difficult to mention any other economic variable with such an extreme and relatively persistent growth rate.
Author: Karlo Kauko
Source: Research Discussion Papers, Bank of Finland
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