Factors affecting the ratio of currency demand to total monetary assets in Malta

Abstract

There are a number of factors influencing individuals` and firms decisions to hold currency rather than other forms of monetary assets. An important motive is to buy consumer goods and services in the case of individuals, and to pay wages and salaries and other short term business expenses in the case of firms. This can be loosely be called the “transactions” motive. Another reason, loosely termed here as the “asset” motive, is related to changes in the rate of interest. In macroeconomic theory, we also encounter the “speculative” motive which is related to expected, rather than actual changes in interest rates. Another reason, which is of some importance in the Maltese economy, is to conceal economic activity for tax evasion. Thus underground activity covers production which is not, but should be, included in the computation of GDP. The purpose of this paper is to propose a model which associates currency demand with the underground economy and which quantitatively estimates the elasticities associated with currency demand. An attempt will be made also to estimate the size off the underground economy in Malta.