Estimated Money Demand Research Articles

The Monetary Instrument Matters

This paper revisits the issue of the money supply versus the interest rate as the instrument of monetary policy. Using a dynamic stochastic general equilibrium framework, we examine the effects of alternative monetary policy rules on inflation persistence, the information content of monetary data, and real variables. We show that inflation persistence and the variability of inflation relative to money growth depend on whether the central bank follows a money growth rule or an interest rate rule. With a money growth rule, inflation is not persistent and the price level is much more volatile than the money supply. Those counterfactual implications are eliminated by the use of interest rate rules whether prices are sticky or not. A central bank’s utilization of interest rate rules, however, obscures the information content of monetary aggregates and also leads to subtle problems for econometricians trying to estimate money demand functions or to identify shocks to the trend and cycle components of the money stock.

The Monetary Instrument Matters

This paper revisits the issue of money growth versus the interest rate as the instrument of monetary policy. Using a dynamic stochastic general equilibrium framework, we examine the effects of alternative monetary policy rules on inflation persistence, the information content of monetary data, and real variables. We show that inflation persistence and the variability of inflation relative to money growth depends on whether the central bank follows a money growth rule or an interest rate rule. With a money growth rule, inflation is not persistent and the price level is much more volatile than the money supply. Those counterfactual implications are eliminated by the use of interest rate rules whether prices are sticky or not. A central bank's utilization of interest rate rules, however, obscures the information content of monetary aggregates and also leads to subtle problems for econometricians trying to estimate money demand functions or to identify shocks to the trend and cycle components of the money stock.

The Stability of Emu‐wide Money Demand Functions and the Monetary Policy Strategy of the European Central Bank

In this paper we investigate whether monetary aggregates could play a role as either intermediate targets or indicators of the single monetary policy of the European Central Bank (ECB). To this end we estimate money demand functions for the European Economic and Monetary Union and test for their stability. Our estimations suggest that M3H in particular can play a role in both a monetary and an inflation targeting strategy. If the ECB chooses to opt for an inflation targeting strategy MR and even M1, in addition to M3H, may well serve as important indicators, alongside a number of other financial and real variables.

Transaction Services, Inflation, and Welfare

This paper is motivated by empirical observations on the comovements of currency velocity, inflation, and the relative size of the credit services sector. We document these comovements and incorporate into a monetary growth model a credit services sector that provides services that help people economize on money. Our model makes two new contributions. First, we show that direct evidence on the appropriately defined credit service sector for the United States is consistent with the welfare cost measured using an estimated money demand schedule. Second, we provide estimates of the welfare cost of inflation that have some new features.

Monetary dynamics in Ghana: evidence from cointegration, error correction modelling, and exogeneity

There exists cointegration among nominal money stock, price, real income, exchange rate, and exchange risk over the period 1970.4 to 1992.4. The error correction factor between the long-run and short-run dynamics is about 6% which is slow. The price homogeneity postulate and long-run income elasticity obtain in the country. The estimated money demand function and parameters are stable, significant, and compare favourably with other studies for other countries. Price and income are both weakly and super exogenous. Finally, M1 remains the most suitable definition of money for effecting monetary policy changes in the country.

On the Reinterpretation of Money Demand Regressions

A stylized fact concerning estimated money demand relationships is that lagged dependent variables have high explanatory power and large estimated coefficients, which is hard to explain at a theoretical level. Marvin S. Goodfriend (1985) suggests that this may be due to the presence of serially correlated measurement errors in the independent variables. The author demonstrates how consistent estimates of the short-run demand function can be obtained even if the Goodfriend hypothesis is accepted and also how the hypothesis might be tested. Application of the suggested test using the Goldfeld (1973) data set leads to decisive rejection of the hypothesis. Copyright 1994 by Ohio State University Press.

An empirical test of the effects of government deficits on money demand

There is a great deal of interest in how govenment deficits affect macroeconomic variables. Accordingly, there is a large body of theoretical and empirical work on the topic. This paper examines the relationship between deficits and interest rates. Among the difficulties in exploring this relationship is that when conducting monetary policy, the Federal Reserve often targets interest rates. Such a policy can cloud any relationship between deficits and interest rates. A way to avoid this problem (among others) is to estimate money demand functions that contain a measure of the market value of government debt. No evidence is found to support a positive relationship between government debt and money demand. This finding implies budget deficits do not affect interest rates through money demand.

Money Demand in a High Inflation Economy: The Case of Israel

Money demand plays a central role in recent models of rapid inflation and stabilization which are highly relevant to the Israeli economy. This paper uses co-integration analysis to estimate money demand in Israel. We find that money demand shifted at the beginning of the 1980s, probably as a result of increased use of liquid indexed assets which provide protection against high inflation. In the previous two decades the equation was a fairly conventional 'U.S.-type' logarithmic function. In the last decade the equation has had a lower constant and has exhibited less sensitivity to interest rate changes. In both periods the nominal rate of interest and real private consumption have been co-integrated with real M1 balances, and interest elasticity has been less than unity. Copyright 1994 by MIT Press.

The demand for money in the Netherlands and the other EC countries

This paper presents an analysis of the demand for money in each of the single EC countries, using a uniform data set and a common economic framework. The analysis differs from other studies in two major respects. Firstly, a countrywise set-up is chosen instead of an analysis of EC aggregates and secondly, three monetary aggregates —M1, M2, andM3 — are analysed. This approach does justice to possible differences in money demand behaviour in the various countries and avoids the aggregation problem. The estimated money demand equations belong to the class of error-correction models and offer a tool for interpreting differences in monetary developments in the single EC countries. The estimation results show that in most member states the price elasticities are slightly below 1. Other remarkable results are that the demand for money in the southern EC countries is less sensitive to changes in the interest rates and the inflation rate than in the northern countries and that the demand for broadly defined money is more stable than the demand for narrow money. Stability also seems to depend on the size of the country. By weighting the estimates for the individual countries, elasticities of the demand for money of the EC as a whole are obtained, which have a plausible order of magnitude.

Money demand in an open economy

This paper considers the specification of the demand for money in Japan in an open economy context. The importance of considering the rates of return on foreign-currency-denominated assets and disaggregating money by currency denomination and the residence of the holder is emphasized. Estimated money demand equations for resident holdings of yen-denominated M1 and M2 are presented. These equations are used to determine the quantitative impact of the 1980 foreign exchange law on portfolio substitution between domestic money and foreign assets. Portfolio shifts in response to changes in economic variables and the foreign exchange law do not seem to have had a significant influence on the demand for money in Japan.

Money-Demand Variability: A Demand-Systems Approach

This article tests the Fourier flexible form on quarterly U.S. monetary data. The data have been prescreened for consistency with the general axiom of revealed preference, and subindexes are formed using the Divisia approach. In this article, the global Fourier model fits well, although there is a potential problem of overfitting and certain data points exhibit behavior inconsistent with the model. The elasticities are variable over time, particularly around business-cycle troughs. It appears that financial asset demand surfaces are highly nonlinear and the many unsuccessful existing attempts to estimate money demand may not have worked well for this reason.

Money-Demand Variability: A Demand-Systems Approach

This article tests the Fourier flexible form on quarterly U.S. monetary data. The data have been prescreened for consistency with the general axiom of revealed preference, and subindexes are formed using the Divisia approach. In this article, the global Fourier model fits well, although there is a potential problem of overfitting and certain data points exhibit behavior inconsistent with the model. The elasticities are variable over time, particularly around business-cycle troughs. It appears that financial asset demand surfaces are highly nonlinear and the many unsuccessful existing attempts to estimate money demand may not have worked well for this reason.

U. S. Money Demand: Surprising Cross-Sectional Estimates

We estimate money demand functions using cross-sections of U.S. states over the period 1929-1990. We arrive at a number of interesting conclusions: First our estimates of the income elasticity lie between 1.3 and 1.5 significantly above one. Second money demand is a stable function over an impressive sample period 1929-1990. Third income per capita is a better scale variable than consumption. And finally after having been fairly constant between 1950 and 1980 the rate of technological progress (which determines the amount of money demanded for given incomes price levels and interest rates) accelerated substantially over the 1980s. (authors)

An alternative monetary policy target

For most of the period since the mid-1970s, the Federal Reserve has expressed its monetary policy intentions by announcing the target growth rates of three principal monetary aggregates: the simple-sum M1, M2 and M3. However, the sweeping changes and the deregulation in the financial industry have greatly affected the relevance of these traditional monetary aggregates. The unusual behaviour of the simple-sum monetary aggregates has forced the Federal Reserve to stop setting target range for M1. The measuring of monetary aggregates has become a controversial question. This paper constructs the new-benchmark Divisia monetary indexes which reflect ‘moneyness’ more accurately than the old Divisia indexes. I demonstrate that the historical trends of the Divisia monetary indexes are sensitive to the brenchmark rates chosen in constructing these indexes. In addition, I compare the forecasting performance of the new-benchmark Divisia monetary indexes with the simple-sum and the old Divisia monetary indexes in the estimated money demand functions. I find that the new-benchmark Divisia monetary indexes provide the best statis forecasting performance. The result indicate that the new-benchmark Divisia monetary indexes should be considered as alternative measures of money in studying the relationship between money and the economy.

The Demand for Money in Developing Countries: Assessing the Role of Financial innovation

Traditional specifications of money demand have been commonly plagued by persistent overprediction, implausible parameter estimates, and highly autocorrelated errors. This paper argues that some of those problems stem from the failure to account for the impact of financial innovation. We estimate money demand for ten developing countries employing various proxies for the innovation process and provide an assessment of the relative importance of this variable. We find that financial innovation plays an important role in determining money demand and its fluctuations, and that the importance of this role increases with the rate of inflation.

The Demand for Money in Developing Countries: Assessing the Role of Financial Innovation

Traditional specifications of money demand have been commonly plagued by persistent overprediction, implausible parameter estimates, and highly autocorrelated errors. This paper argues that some of those problems stem from the failure to account for the impact of financial innovation. We estimate money demand for ten developing countries employing various proxies for the innovation process and provide an assessment of the relative importance of this variable. We find that financial innovation plays an important role in determining money demand and its fluctuations, and that the importance of this role increases with the rate of inflation.

The demand for money in some major OPEC members: regression estimates and stability results

Numerous studies have empirically examined the money demand function in several developed and developing countries. However, money demand functions in the OPEC economies have been largely ignored. This paper estimates appropriate money demand equations for three OPEC economies, namely Saudi Arabia, Libya and Nigeria. The open-economy nature of the money demand model and its structural stability are stressed and tested. Over the quarterly period 1963 to 1979, the estimated money demand equations for the three countries fit the data quite well and exhibit sturctural stability. Importantly, the inclusion of a variable representing foreign monetary influence into the estimated equations appears necessary for the stability result to emerge.

The demand for money in a developing economy: The case of Kenya

The demand for money function occupies a central role in most theories of aggregate economic activity, especially in the formulation and execution of effective monetary policy. This paper examines the demand for money in the developing economy of Kenya. Special attention is paid to the model specification, its dynamic structure and to its temporal stability. The empirical results show that for both conventional definitions of money (the narrow and the broad), the theoretical model fits the Kenyan data quite well, and the proposed variables are all statistically significant and with the anticipated signs. The results further suggest, based on a battery of tests, that the estimated money demand equations for Kenya are temporally stable. Focus is also given to the open-economy nature of the money demand model, and the results indicate that some measure of foreign interest rates plays a significant role in the Kenyan money demand equations as potentially in any other money demand equation of an open economy. Monetary policy in Kenya, therefore, must take into account the response of domestic money demand to changes in such external factors.

The demand for money in Brazil: Some further results

A recent paper by Cardoso, using the simple Koyck-adjustment mechanism, has estimated a money demand equation for Brazil. The results are said to show, among other things, that the inflation rate does not play a significant role in the Brazilian money demand function. This paper re-examines and expands on the money demand relationship in Brazil, finding that Cardoso's estimated equations are inherently unstable. Using a less restrictive dynamic adjustment mechanism, an alternative money demand relationship has been estimated for Brazil which proves well-fitting and structurally stable over time. The inflation rates variable, furthermore, is found to exert a significant influence on real money demand in Brazil. In fact, without such a variable, our estimated money demand relationship appears toe misspecified and structurally unstable.

The Term Structure of Interest Rates in Money Demand: A Reevaluation: Note

A proper choice of interest rate variables which represent opportunity costs of holding cash balances has been the subject of numerous empirical studies of the demand for money. The choice problem, of course, does not arise in theory because, in principle, the entire spectrum of interest rates affects the quantity of money demanded. The problem is thus an empirical one, caused by the multicollinearity among all theoretically plausible candidates. The common practice in the past has been to choose a set of two or three rates for the estimation. The chosen set varies mainly due to the emphasis on the motive of cash holding, that is, transactionsdemand approach versus portfolio-theoretic approach. A different approach has been taken in the study of Heller and Khan (1979), who attempted to incorporate the entire term structure into the specification of money In their approach the yield curve in each period is first approximated by a quadratic function, and then the estimates of the quadratic function parameters are used in the place of interest rates. Heller and Khan (HK hereafter) reported that the coefficients of the yield curve parameters were all significant and the estimated money demand function was stable over their sample period 1960.III-1976.IV. Allen and Hafer (1983) extended the sample period to 1960.III-1979.IV and also introduced the cubic function to approximate the yield curve. Allen and Hafer (AH hereafter), who used the Hatanaka (1974) estimation method, reported significant coefficients of the yield curve parameters, but the estimated money demand function was not stable over their sample period. 1 Both studies of HK and AH have used the stock adjustment model and have imposed on their estimation equation the conventional restrictions of the unitary long-run price elasticity and the real adjustment process. HK defended their use of the real adjustment model (RAM) by arguing that the nominal adjustment model (NAM) would be applicable only in the case where the nominal money supply responded passively to any excess demand. The RAM, however, has its own drawbacks. In the context of the adjustment cost model, the NAM assumes that an individual incurs an adjustment cost only when he is actively engaged in altering his