This paper presents a survey and new estimates of the demand for narrow money (M1) in Israel between 1990 and 2006. The estimated equations are of the type that Goldfeld (1973) estimated for U.S.; such equations functioned well in Israel since the 1985 Economic Stabilization Program. From the beginning of 2003 to the end of 2006, the quantity of narrow money increased by an accumulated rate of 62 percent, well above than the increase in GDP and the inflation target. The main conclusion of this paper is that the significant increase in the quantity of money from 2003 through 2005:Q3 is accounted for by the equations, mainly due to the sharp reduction in interest rates and the increase in real GDP. On the other hand, a separate examination of the components of narrow money show that in 2001 and 2002 there was substantial increase in the currency component, partly at the expense of demand deposits growth. This phenomenon has no quantitative explanation, but may be related to the worsened security situation (Intifada) and/or the anti-money laundering regulation. From the fourth quarter of 2005 the actual money demand exceeds the equations' forecasts, mostly because of the increase in demand for the demand deposit component. So far, we have not identified a satisfactory explanation for the decrease in the prediction's quality; perhaps it is related to the expansion of financial activity in Israel, but we have not found a quantitative variable that captures this effect; therefore it is important to keep abreast of the developments in the narrow money demand and its components.
