Has M2 demand in the USA become unstable? evidence from an error-correction model

The purpose of this paper is to estimate an appropriate broad-money demand function for the United States and to examine its stability after 1987, when the Federal Reserve System began using M2 as a policy guide. Special attention is paid to the model specification, its dynamic structure, and to its cointegration properties. The results from various dynamic error-correction models suggest that: (i) the money demand relationship is stable; (ii) most previously estimated models have undoubtedly misspecified the interest rate variable; (iii) interest-rate variability is another important determinant of real money demand; and (iv) in contrast of previous studies, the long-run scale variable is real GDP, whereas real consumer spending is the short-run scale variable. The sample period examined is 1953:1 to 1991:4.     

How justified is abandoning money in the conduct of monetary policy in Australia on the grounds of instability in the money‐demand function?

The role of money in the design and conduct of monetary policy has reemerged as an important issue in both advanced and developing economies, especially since the 2007 global financial crisis. A growing body of recent literature suggests that the causal relationship between money supply growth and inflation remains intact across countries and over time and that this relation is not conditional on the stability of the money‐demand function or whether money is endogenous or exogenous. Moreover, critical for a rule‐based monetary policy is the presence of a long‐run stable money‐demand function, rather than a short‐run money‐demand model that may exhibit instability for many reasons, including problems with estimating a money‐demand model with high‐frequency data. Provided that a stable money‐demand function exists, it could be useful to establish long‐run equilibrium relations among money, output, prices, and exchange rates, as the classical monetary theory suggests. Within this analytical framework, this paper addresses the question of whether money has any role in the conduct of monetary policy in Australia. The conventional wisdom is that the money‐demand function in Australia has been unstable since the mid‐1980s due to financial deregulation and reforms; this led to a change in the strategy of monetary policy for price stability in the form of inflation targeting that ignores money insofar as inflation and its control are concerned. This paper reports empirical findings for Australia, obtained from a longer quarterly data series over the period 1960Q1–2015Q1, which suggest that instability in the narrow‐money‐demand function in Australia was primarily due to the exclusion of variables which have become important in the deregulated environment since the 1980s. These findings are confirmed by an expanded form of the narrow‐money‐demand function that was found stable over the past two decades, although it experienced multiple structural breaks over the study period. The paper draws the conclusion that abandoning the monetary aggregate as an instrument of monetary policy in Australia, under a rule‐based monetary policy such as inflation targeting, cannot be justified by instability in the money‐demand function or even by lack of a causal link between money supply growth and inflation.     

Multilateral currency substitution and capital flows as sources of instability in the soe demand for money function — A case study

Using monthly data for Ireland we test the hypothesis that the combined effects of currency substitution and capital mobility renders the demand for money function subject to instability over time. The empirical evidence supports the view that both “the” expected exchange rate change, giving rise to currency substitution, and the latter as a component, along with “the” foreign interest rate, of the gross yield on foreign currency-denominated assets, giving rise to capital mobility, are important determinants of the domestic demand for money. Their inclusion as arguments yields a money demand function which is more stable than if they are (incorrectly) excluded.     

Money creation and credit multipliers ∗

The standard objections against the quantity theory of money, based on the instability of the velocity of money, are insufficient to discard this long-held monetary theory. The principal criticism of the theory rests on the determination of the money supply. The supply of money is a dependent variable, not an independent one. The demand for credit determines the quantity of money, or at the very least bankers and borrowers share the responsibility. Causality is thus reversed. It is necessary to abandon the concept of money multipliers, which are relics of the quantity theory of money. Bankers can, if they so desirerespond without limitto demands for credit. They are not tied by a fixed amount of pre-existing assets. The goal of the article is to outline an explanation of these statements and provide a vision of monetary theory that is different from that usually taught.     

Financial Deregulation and Stability of Money Demand: The Australian Case

This paper analyses the Australian economy in the post-war period. The analysis examines stationarity and cointegrating relationship among output, interest rate and money. The analysis shows that Australia has had a stable cointegrating relationship among output, interest rate and money during the post-war period although the country deregulated its financial sector in the 1980's. Australia's money demand function fails to reject the hypothesis that the interest elasticity of money demand is 0.5. In addition, one specification of the country's money demand function fails to reject the hypothesis that the income elasticity of money demand is unity. The specification is the Vector Error Correction Model that includes real output, real balances, an interest rate, and a deregulation dummy variable, with the lag length of three.     

Are sports teams multiproduct firms?

The appropriate conception of team outputs is investigated by estimating a two-output factor demand system for baseball teams, relative to which single-output models are rejected. This finding is robust to alternative approaches to testing and model choice. The factor demands are those of the symmetric generalized McFadden cost function, which has several advantages in this context. The team factor inputs are the skill characteristics of players, the prices of which are obtained hedonically. In addition to investigating one- versus two-output models, the estimation results are used to obtain demand and substitution elasticities, factor input elasticities with respect to output, cost elasticities, and measures of economies of scale and scope. Although the results support a multiproduct conception of team production, output separability is not rejected, suggesting that team outputs may sometimes be adequately treated as a production aggregate.     

Causality between money and prices in Indonesia

The purpose of this study is to examine the relationship between money supply and prices in Indonesia, where money supply is taken to be the stock of narrow money (currency + demand deposits) and prices are proxied by the Jakarta cost of living index. The period studied is 1969–1980. Two concepts of causality namely “proper” causality in which the causal effect takes at least one quarter to manifest itself and “instantaneous” causality in which there are no lags, are employed. The hypothesis of “proper” causality is rejected by bothGranger andSims tests. However, the hypothesis that money and prices are contemporaneously correlated cannot be easily dismissed. Using the framework of [Geweke], contemporaneous causality is treated as a part of linear feedback and the lagged version of Sims test was used. We found that the hypothesis that prices cause money supply cannot be dismissed on the basis of Wald test. However, the contribution of instantaneous causality is very large to the total variance of linear feedback.     

Production and costs in the South African motor vehicle industry

This study investigates the existence of economies of scale in the South African motor vehicle industry as well as the substitution possibilities between input pairs and the direct and cross-price elasticities of demand for the various inputs. Because of data limitations, a translog cost function was estimated for only a three input model corresponding to a homogeneous production function involving capital, labour and intermediate goods. The issue of the existence of economies of scale in the South African motor vehicle industry is a particularly important one because South Africa once again is a member of GATT and a full participant in the international trade arena. The null hypothesis of constant returns to scale was rejected at the 0.5% level of significance. Thus, the results of this model are certainly consistent with economies of scale in the South African motor vehicle industry. The estimated direct price elasticities were consistent with the hypothesis that, during the past two decades, capital was the productive factor with the most elastic demand, and the estimated cross-elasticities between input pairs generally supported the hypothesis that all inputs are substitutes.     

Monetary targeting in the Netherlands: an application of co-integration tests

There are two criteria to choose an intermediate variable for monetary targeting. First, the money demand function needs to be stable and second, the monetary authorities should be able to control the target variable given the available instruments. In this paper we examine whether M1 and M2 in the Netherlands fulfil the first requirement, i.e. we investigate whether a stable relationship exists between these monetary variables and key macroeconomic variables. Co-integration techniques are used which are very well suited for this purpose. Monetary policy in the Netherlands has been directed towards the growth rate of broad money (M2). The present findings do not suport the choice of M2 as an intermediate target for monetary policy in the Netherlands. A stable long-term relationship between M2 and real NNP and Long-and short-term interest rates does not exist. The results for M1 are considerbly better, though not favourable at all scores. The estimated moeny demand function for M1 is a good indicator for monetary policy, since the Dutch central bank probably cannot control the growth rate of M1.     

MONETARY ANTICIPATONS AND THE DEMAND FOR MONEY SOME UK EVIDENCE*

The Carr-Darby ‘shock-absorber’ hypothesis, that unanticipated changes in the money supply influence the demand for real money balances but anticipated changes do not, is tested on UK data for narrow money, M1. For comparison with earlier studies on US data we take the (real first order) partial adjustment model as one example of a ‘conventional’ demand for money function. However the Carr-Darby hypothesis is also tested taking a more general autoregressive distributed lag model as the ‘conventional’ demand function. For both ‘conventional’ demand for money functions we find that the shock-absorber hypothesis is not supported for M1 using UK data.     

Generalized functional forms and demand for money in an open economy: the case of the United Kingdom

The purpose of this paper are twofold:first, to apply a Box–Cox model to the UK money demand relationship within an open economy framework in order to empirically investigate the proper functional form supported by the data in this general setting. Secondly, to test for the porper scale variable in the UK money demand function within the open economy Box–Cox specification. These improvements enhance the accuracy of our measures of monetary and fiscal policy effects and our understanding of the interdependence between different economies. The empirical results derived here reject the restrictive linear and log specifications in favour of the general Box–Cox model under both income and consumption-based money demand specifications. The traditional income-based model, however,escaps unharmed from the challenge put forward by Mankiw and Summers (1986).     

Towards a more general approach to testing the time additivity hypothesis

A new procedure is proposed for re-examining the assumption of additivity of preferences over time which, although untenable, is usually maintained in intertemporal analyses of consumption and labour supply. The method is an extension of a famous work by Browning. However, it is more general in permitting the estimation of intertemporal demand systems, which are explicit in an unobservable variable (price of utility), but may lack a closed form representation in terms of observable variables such as prices and total outlay. It also makes extensive use of duality theory to solve the endogeneity problem encountered in Browning's study. Applying this method with an appropriate estimator to the Australian aggregate data, it is found that the time additivity hypothesis is decisively rejected, which is consistent with Browning's conclusion.     

An empirical note on bond-yield uncertainty and the demand for money

This paper empirically tests the effect of bond-yield uncertainty on the demand for money, as implied by the capital theory approach to the demand for money, suggested by Friedman and Tobin. It is expected that the demand for money is affected not only by the yield on bonds (which are a substitute asset), but it also in increasing function of their risk. The empirical tests, which employ two alternative measures of uncertainty (mean of squared deviations from the average, and the mean of squared deviation from a predictor obtained by exponential smoothing) seem to support the Friedman-Tobin hypothesis.     

Real purchasing power in the neoclassical monetary growth model

In the one sector neoclassical monetary growth model, the balanced growth path under perfect foresight is a saddle point. The paper demonstrates that this instability problem can be resolved by entering real purchasing power into the liquidity preference function as well as into the consumption function. This process allows an additional mechanism based on income effects in money demand by which a change in real balances can influence the growth path. Stability now depends critically on the size of such income effects given wealth effects from money demand. If stability is restored, the nature of the traditional non-neutrality of money must be qualified.     

Financial innovation and demand for money: some empirical evidence

Recent criticism of money growth targets has been based on the implications of spreading financial innovation, since the latter has been considered to undermine monetary policy effectiveness both by bringing about an increase in the interest elasticity of money demand and by producing instability of the money demand function. The empirical results presented in this paper – focusing on a single and specific case of financial innovation particularly suited to study the isssue at stake – falsify both hypotheses.     

Interest Rates and Monetary Velocity in Australia and the United States*

Two problems have become evident in recent work on the demand for money. One is the implausibly long lags in the demand for money function, the other is a tendency for short-run instability during the 1970s. This paper argues that these problems stem from a point raised by Milton Friedman in 1959 but neglected subsequently: namely, the failure of reference cycles in interest rates to conform in timing with cycles in velocity. The cyclical association between interest rates and velocity is examined for both Australia and the US using cross-spectral methods, and evidence is found of the timing relationships which puzzled Friedman and led him to doubt that interest rates significantly affected the demand for money. After considering the implications of these findings, it is concluded that many models of the demand for money appear to be mis-specified, and the two problems mentioned above are symptomatic of this. A different approach to modelling the demand for money is outlined, in which a short-lead relationship in the money market is substituted for the long lags found by other researchers.     

中国经济转型与货币需求

本文采用"从一般到特殊"的动态建模方法对中国经济转型过程中的货币需求函数进行了再估计,通过引入市场化进程相对指数作为衡量经济转型的制度变量考察货币需求、经济增长、通货膨胀、利率和经济转型之间的相互关系。结果发现,尽管1978—2007年间30年的改革开放使得中国的经济体制和金融体系发生了较大的转型,但通过引入适当的制度变量,仍然可以得到稳定的货币需求函数。本文建立的货币需求动态模型证实了经济体制的市场化转型无论长短期都是拉动货币需求增加的因素,通货膨胀是解释货币量的有效外生解释变量,短期内利率变量对实际货币需求影响不显著,但其确实显著地进入了长期货币需求关系。     

Financial innovation,depository-institution deregulation,and the demand for money

Our hypothesis is that financial innovation and depository-institution deregulation explain much of the seeming instability in the post-1973 money demand. Following a procedure similar to that employed by Hafer and Hein (1982) and Hafer (1982), we conclude that money demand experiences three periods of gradual intercept drift—two down and one up—rather than several one-time shifts. The gradual intercept drift is consistent with our hypothesis of financial innovation and depository-institution deregulation. Furthermore, after accounting for the gradual drift, the resulting full-sample regression are well-behaved.     

The demand for money and the variability of the rate of inflation : An emperical note

In this note we incorporate the effect of inflation variability on the demand for money in Pakistan. It is found that this variable has a significant impact on money demand function. Our results are similar to those of Klein while they differ with Blejer.     

The role of money demand functions in one-sector growth models

This paper shows that the assumption made regarding the functional form of the demand for money has a crucial role in determining the effect of the rate of inflation on the steady-state capital intensity in a one-sector monetary growth model. It is also indicated that by introducing money into a growth model, which assumes a fixed coefficient technology production function and a homogeneous savings function, a long-run instability problem can be avoided, irrespective of the form of the money demand function.