Money demand, expectations, and the forward-looking model

Abstract

A great deal of ingenuity and creativity have been applied to the study of the demand for financial assets and, in particular, monetary assets. Broadly speaking , in both the United Kingdom and the United States the period up to 1971 was one of optimism as far as establishing a stable demand function was concerned. In the 1970s it was a widely held view that the demand for U.K. broad (e.g. , £M3) had become unstable , and the pace of financial innovation in the 1980s has also led to increasing doubts about the stability of narrow (Ml) (Hall et al. , 1989). A broadly similar pattern of events emerged in the United States , with much debate centered on the period of the missing money in the mid-1970s and the great velocity decline in the early 1980s. Perhaps the 1980s can best be described as the years of uncertainty as far as the empirical characteri stics of the demand for are concerned (Taylor , 1987a). Throughout the 1970s and 1980s there have been no major innovations in theories of the demand for that have led applied monetary economists radically to alter their modeling strategy (Fischer, 1988). Indeed, we would wish to argue that it is innovations in the field of applied econometrics-particularly the interrelation between cointegration, error correction models (ECM), and forward-looking