PRECAUTIONARY DEMAND FOR MONEY AND ECONOMIC UNCERTAINTY: EVIDENCE FROM THRESHOLD EFFECT OF INSTITUTIONAL DEVELOPMENT

A notable feature of empirical studies on the unknowns about future economic events that lead to precautionary demand for money among economic agents is that very few studies put emphasis on the role of institutional development in mediating the relationship between them. To overcome this shortcoming, this study examines the threshold effect of institutional development on the relationship between precautionary demand for money and economic uncertainty, without neglecting the roles of income, the interest rate and the exchange rate in the money demand function in 28 economies. The empirical results from the panel threshold methods demonstrate significant threshold effect for these determinants, especially for economic uncertainty, which indicate that a better understanding that the relationship between the precautionary demand for money and economic uncertainty may be contingent on institutional development could help policy makers fine-tune the money demand function in a more precise manner to achieve the optimal liquidity provision under economic uncertainty over time.