The stability of the US money demand function

The objective of this article is to explain why the traditional demand for money function has failed to anticipate US monetary aggregate (M2) movements since the early 90s. The standard definition of the opportunity cost of holding M2 has, in fact, become inadequate as it has led to overestimate the effect on M2 of the Federal Reserve expansionary monetary policy (1990-1993). The introduction of long-term rate in the opportunity cost, backed up by theoritical and economic arguments (portfolio choice model and growth of mutual funds), improves the predictive power of the demand for money function over the recent period. In this new framework, the coefficient of the long-term interest rate is linked to the risk attached to long-term investments.