Abstract
The purpose of this paper is to estimate a parsimonious model of money demand. The model relates international crude oil prices to the US money stock with the addition of a valuation adjustment. The main conometric estimation procedure is the autoregressive distributed lag approach. The model is checked for robustness by changing the econometric procedure to the Johansen estimator, by changing the functional form of the conditional variance, and by applying alternative cointegration tests. Oil prices and the US money stock move in tandem in the long run. The association is unit proportional which implies money neutrality. The major conclusion is that oil prices have an anchor, which is the US money stock, and no event whether intended or unintended is capable to destabilize the model. Hence monetary authorities are passive observers, and cannot manipulate economic variables to control real oil prices in the long run.
Highlights
Oil prices are a major indicator of worldly performance, and are widely and quickly publicized, and are scrutinized and monitored by very diverse economic agents
What is surprising is that oil prices, like for example the west Texas intermediate (WTI), provide a zero monthly return, making oil an exceptionally bad investment, unlike gold which has a noticeable positive price appreciation and return
This monetary link by oil unto US money is consistently proportionate, meaning that in the long run money is neutral on oil prices
Summary
Oil prices are a major indicator of worldly performance, and are widely and quickly publicized, and are scrutinized and monitored by very diverse economic agents. Oil is characterized by a convenience yield, which makes oil attractive to hold physically and its possession insures that markets are not subject to perturbation. This might explain the magnitude of US oil reserves. One of the main conclusions of this paper is that oil prices fluctuate relative to US money, after having removed valuation effects This monetary link by oil unto US money is consistently proportionate, meaning that in the long run money is neutral on oil prices. This result is obtained by applying different econometric techniques to check the general robustness of the effect. It is astonishing that such a simple model was not discovered previously
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