Monetary Anticipations and the Demand for Money in the U. S.: Further Results

Abstract

A flourishing debate has arisen in the literature concerning both the interpretation of the original Carr-Darby [1] (C-D) shock-absorber approach to the for and the choice of an appropriate estimation technique for empirical tests of the hypothesis. The C-D hypothesis holds that unanticipated shocks to the supply are partially accommodated by a temporary increase in short-run real balances, whilst anticipated monetary movements are reflected in the current price level and so are neutral with respect to the level of real holdings. C-D test this proposition by generating monetary anticipations series (by fitting univariate ARIMA processes) which are then substituted into fairly standard, partial adjustment equations. Using this two-step technique they find empirical support for the hypothesis for a number of countries. Mackinnon and Milbourne [13] (M-M) argue that the C-D method may be subject to a simultaneity bias which can be corrected by an appropriate reparameterisation. They then produce empirical evidence, using their reparameterisation, which appears to overturn the C-D results, at least for U.S. data. In a rejoinder to M-M, Carr, Darby and Thornton [2] (C-D-T), argue that standard monetary economics and, indeed, the logic of the C-D hypothesis suggests that the stock should be taken as exogenous at the aggregate level and that the aggregate money demand equation is in fact a price equation. If this is the case then the variable appears on the left hand side of the aggregate money demand equation merely to impose price level homogeneity and, in particular, the augmented or shock absorber equation can be consistently estimated by ordinary least squares (OLS) (assuming the exogeneity of other regressors). We argue below that the hypothesis does not make sense unless is taken as exogenous.