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Demand for Money

Chapter 8

THE

DEMAND

PERTAINING TO

MONEY

SOPHIE M. GOLDFELD

Princeton University or college

DANIEL E. SICHEL*

Panel of Governors of the Federal government Reserve System

Contents

1 ) 2 .

Introduction Overview of empirical difficulties

installment payments on your 1 . installment payments on your 2 . U. S. cash demand Money demand: Intercontinental evidence A quick theoretical guide A variable-by-variable review Money demand plus the partial adjusting mechanism Criticisms and adjustments of the part adjustment version Dynamic designs that impose long-run human relationships Simultaneity, exogeneity, and the mother nature of the modification process

several.

Re-examining the standard specification

3. 1 . several. 2 .

three hundred 302 302 306 308

308

four.

Econometric problems

4. 1 ) 4. 2 . 4. three or more. 4. 4.

5. Concluding remarks Recommendations

313 324 325 333 338 341 349 353

* We thank Benjamin Friedman pertaining to his feedback. The views expressed are those of the authors; they just do not necessarily reveal the opinions of the Plank of Governors of the Federal Reserve Program.

Handbook of Monetary Economics, Volume I, Edited by B. Meters. Friedman and F. They would. Hahn В© Elsevier Science Publishers M. V., 1990

300

T. M. Goldfeld and M. E. Sichel

I. Introduction The regards between the demand for money balances and its determinants is a fundamental building block generally in most theories of macroeconomic behavior. Indeed, many macroeconomic designs, whether theoretical or econometric, generally ignore the rich institutional detail of the financial sector and make an attempt to capture financial factors with the demand and provide of money. Furthermore, the demand for money is a critical component in the formulation of monetary policy and a reliable demand function for money is definitely perceived as a prerequisite for the use of monetary aggregates in the carry out of plan. Not surprisingly, in that case, the demand for money in many countries has been subjected to extensive empirical scrutiny. The evidence that emerged, at least before the mid-1970s, advised that a couple of variables (essentially income and interest rates, with appropriate allocated for lags) were capable of providing a plausible and stable reason of money demand. As continues to be widely documented, especially for the United States but anywhere else as well, issues have been noticeably less adequate since the mid-1970s. First, there were the instance of the " missing m o and e sumado a " when conventional cash demand equations systematically overpredicted actual cash balances. Furthermore, attempts to fit conventional demand functions into a sample that included the missing funds period invariably produced unbekannte estimates with a few quite irrational properties. Second, in the 1980s, U. S i9000. money require functions, if fixed up to explain the 1972s, generally displayed extended times of underprediction as discovered velocity droped markedly. To make certain, the period because the mid-1970s have been marked by simply unusual economical conditions in many countries including source shocks, extreme bouts an excellent source of and adjustable inflation, record-high interest rates, and deep recessions. The period as well coincided with the widespread usage of suspended exchange rates and, in several major commercial countries, with substantial institutional changes brought about by financial innovation and financial deregulation. Wherever institutional modify was specifically marked, additionally, it led to a change in what we believe of while " m o and e sumado a ". The time since 1974 thus presented a very extreme test of empirical cash demand human relationships and it is perhaps not so amazing that this period succeeded in exposing several shortcomings in existing requirements of money demand functions. 1 lit is perhaps ironic that the emergence of these shortcomings roughly coincided together with the adoption by a number of central banks of guidelines aimed at focusing on monetary aggregates. Some have got argued that the association is far more than pure coincidence. In any event, given the vested interest of policymakers in the lifestyle of a reliably stable...

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