Analysis of Three Variable VECM Models Including Demand Functions for Real Balances

A stable US money demand function, 1874–1975

Abstract. This paper attempts to find those determinants stirring the function of money demand in Sri Lanka during 1975-2013. The empirical analysis starts from applying the unit root tests i.e. Ng-Perron. We apply ARDL bound testing approach of co-integration to scrutinize the co-integration in variables. We select independent variables like per capita GDP, interest rate, exchange rate, fiscal deficit, urban population and rural population to determine money demand function. The findings revealed that income, interest rate and fiscal deficit effect money demand significantly and positively. The exchange rate affects negatively and significantly upon money demand. The stable money demand function is found over time applying CUSUM and CUSUMSQ stability test. The model of our study strongly recommends the real demand for M2 is vital monetary aggregate in terms of policy implication including the appropriateness of model in Sri Lanka. Keywords. Sri Lanka, Money demand, Income, Interest rate, Exchange rate, Fiscal deficit, Urban and Rural Population. JEL. D10, E41, E59.

This paper derives the monetarist version of broad money demand function for Sri Lankan economy using the quarterly data for the period from 1988: Q1 to 2012: Q4. This study employs both Johansen and Juselius (1990) multivariate method and Granger’s (1987) two-step method for cointegration to obtain structural values of the long-run money demand function: The stability of the model is tested using recursive coefficients and cumulative sum of squared residuals (CUSUM) tests. Results obtained from both co-integration testes suggest that the income elasticity of broad money demand is equal to one. Hence, it would provide an important guidance for the monetary authorities to regulate money supply as the intermediate target in order to achieve the final goal/goals of economic and price stability via the monetary transmission mechanism. This study concludes that growth of money over and above the real GDP growth will result inflation. The structural estimate received for inflation is higher than that of the real Treasury bill rate. Both the estimates are in theoretically expected signs and are also statistically significant. It means that public in Sri Lanka tend to substitute money for more real assets than the alternative financial assets during the time of higher inflation. Our tests on the stability of the broad money demand function confirmed that it is stable over time.

The paper tests the null hypothesis of a stable long-run money demand in South Africa over the period 1970-2013. We employ the Gregory-Hansen (GH) method to test for the possibility of structural breaks in the money demand function. The Johansen Maximum likelihood procedure is carried out to determine the cointegration vector from which existence of one cointegrating vector is supported. Also based on the GH criterion, there is existence of one cointegrating vector. GH proposes three structural breaks for the money demand function. Results suggest that endogenous breaks occurred in 1991 and 1994. The GH cointegration equations reject M1 whilst M2 and M3 pass and we proceed to estimate the error-correction model. Complemented by the CUSUM and CUSUM of squares, the tests carried out suggest that monetary policy shifts did not introduce instability.

This paper investigates whether there exists a stationary long-run equilibrium relationship between real money balances, real income, inflation and expected depreciation in Tanzania which can be identified as a money demand function. As the institutional and regulatory framework in Tanzania has undergone a series of changes since economic reforms began in the mid-1980s, shifts in parameters over time might have occurred, causing instability in the money demand function. Using Johansen's maximum likelihood and dynamic modelling procedure, the paper finds equilibrium in the long run and a stable money demand function. These findings imply that, even though economic liberalization and relaxation of controls could have induced instability in the money demand function as conjectured in the literature, such instability was not significant enough to inhibit the estimation of short- and long-run demand for money. Copyright 1999 by Oxford University Press.

This paper analyses the monetary policy channels in Spain using a cointegrated structural VAR approach which explicitly accounts for endogenous policy reactions in a small open economy. Evidence is found of one cointegrating relation which is identified as a long-run money demand function. In addition, stability tests are applied to this relationship to assess whether there has been a change of monetary regime. The impulse-responses for the non-monetary shocks as well as the absence of the puzzles traditionally found in the empirical literature, suggest that the model specification identifies the monetary policy shocks correctly. Thus, according to our results, a monetary contraction causes a weak downward response in the price level, as well as an increase in both short and long-run nominal interest rates, a decrease in aggregate output and an exchange rate appreciation.

The paper estimates the long run demand for money function in the Bangladesh economy using cointegration and the Vector Error Correction Modeling (VECM) technique. The cointegration results suggest that although the process of globalization has shown no significant impact on money demand by the fact that the foreign interest rate is seen as statistically not significant, the financial liberalization has an important impact, reflected in the statistically significant role of domestic interest rate, in influencing both M1 and M2 money demand. An estimate of VECMs also reveals the fact that the short run speed of adjustment is moderately influenced by the financial reform measures to establish the long run relation between money balances, income and domestic interest rates. The phenomenon of credit constraint in the context of a developing country has shown no significant role in influencing money demand, which may imply that the stage of financial development is getting higher level in the Bangladesh economy. The existence of exchange rate depreciation in the cointegration relation with the expected sign suggests that currency substitution is now effective in the monetary sector and, therefore, its impact should be considered in the Bangladesh monetary policy matrix.

The empirical estimates for the money demand function reported here are based on quarterly time series for Saudi Arabia for the period 1962/I to 1981/IV. The money demand function estimated in this article is novel in that it takes into account the potential effect of external monetary and financial factors on domestic money de‐mand in the open economy of Saudi Arabia. The empirical results show that these external factors (foreign interest rates and exchange rates) do play an important role in the Saudi money demand function. Hence, the Saudi monetary authorities should not ignore the response of domestic money demand to these external factors in formulating their stabilisation policies. The empirical evidence also indicates that the inflationary expectations and permanent real income variables exert significant influences on money demand, with the latter variable exhibiting a unitary long‐run elasticity. Finally, the estimated money demand equation is found to be structurally stable over time.

The adequacy of future sugar availabilities for United States consumption requirements since the 1960 embargo on Cuban sugar is a matter of continuing concern. This article gives estimates of the long‐run effects of this embargo on the world and the United States sugar economies as well as of the efficiency of current United States long‐run sugar supply policy. Long‐run supply and demand functions were estimated and a general equilibrium competitive model was constructed. Comparison of the results of this competitive model with projected results of the present United States sugar supply program demonstrates the potential economic inefficiencies of the program.

Recently, Fair (1987) has addressd an interesting question in the areas of demand for money, namely, whether the adjustment of actual to desired demand for money is in nominal or real terms. His conclusion, based on time-seies analysis for twenty-seven countries, including a few developing countries, was that the evidence was overwhelmingly in favour of the nominal hypothesis. The aim of this paper is to address the same issue for eleven Asian countries. In the process, a reformulation of the test procedure used by Fair is suggested. In addition, the question is also examined within the framework of the error correction model. The models are also tested for structural stability. The scheme of the paper is as follows. The models and the tests are specified in Section I. The data and the estimation issues are dealt with in Section II. Section III presents the results. The paper is concluded with a brief summary of the major findings.

Journal Article Neoclassical Consumer Demand Theory and the Demand for Money Get access D. G. Barr, D. G. Barr Bank of England Search for other works by this author on: Oxford Academic Google Scholar K. Cuthbertson K. Cuthbertson University of Newcastle Search for other works by this author on: Oxford Academic Google Scholar The Economic Journal, Volume 101, Issue 407, 1 July 1991, Pages 855–876, https://doi.org/10.2307/2233859 Published: 01 July 1991

The purpose of this paper to apply the new econometric literature on non-nested hypothesis testing to the issue of whether income or the appropriate scale variable in money demand functions. This important for two reasons. First, as MacKinnon points out empirical work using non-nested hypotheses tests still all but non-existent [11, 106]. Hence this paper helps fill one significant void in the applied econometrics literature. Second, the issue is it income or it wealth an important one, (as explained below) but, unfortunately, an unsettled one. Early research by Chow [1], Laidler [7] and Meltzer [12] that utilized a variety of goodness-of-fit and t tests generally concluded that the appropriate variable. The results of more recent research utilizing the same methodology are mixed. For example, Goldfeld [6] and Lieberman [10] argue income the appropriate variable, while Friedman [3] argues it wealth. The view taken in this paper that even though the argument over the proper scale variable an old one, it remains an important one and deserves to be examined through the prism of new econometric methods. The issue of the relevant scale variable remains important because the money demand function plays a crucial role in both monetary and fiscal policy. On the monetary side, successful implementation of an interest rate approach to money stock control rests on the Federal Reserve's use of the correct money demand function. If the Fed employs a misspecified money demand function, it will not know the federal funds rate that consistent with its money targets and, as a result, will miss those targets. Similarly, money demand plays a crucial role in fiscal policy. If money demand does not depend on wealth, then the often cited portfolio crowding out effect that monetarists claim offsets bond-financed fiscal stimuli [4] non-existent. Hence, even bond financed government purchases are expansionary.

This article attempts to estimate the demand for Indonesian behavior money in 1997.1 – 2002.4 using non stationary technique. A new asymptotic theory of regression is introduced for possibly non stationary time series. These techniques are less dependent Johansen’s maximum likelihood of co integration but more depend on the ordinary least squares (OLS) estimation of the equation included in the ECM. The dynamic OLS estimation proposed by Phillips & Loretan in 1991 is used to estimate cointegration. Meanwhile, Vector Autoregresion (VAR) is used to forecast the model which has an interelation time series. Since it desirable to include national income and exchange rate as regressor in the money demand function. To estimate demand function in the short run is used autoregressive distributed lag ECM/ADL ECM, which known Hendry type ECM. The results have find that there are non stationary condition in the time series data in the research. Meanwhile, the estimation with VAR, DOLS and ADL ECM is suggested that volatility of exchange rate impact to demand for Indonesian money.

The assumption of a stable long-run demand for money —i.e of a long-run relationship between real money balances, real output and an interest rate— is one of the main building blocks of modern macroeconomic theories. Moreover, it is a basic requirement for a policy of targeting a monetary aggregate as being practised —at least verbally— by the leading central banks since for than 15 years. However, beginning with Goldfeld’s (1976) “puzzle of missing money” in the United States hundreds of empirical studies have not provided a clear-cut support for the hypothesis of a stable demand for money function for various countries and different time periods since the mid 1970s(1). Evidence for Germany is mixed, too, although there is the presumption that instability of the German money demand — if there is any at all— is not as pronounced as in other countries(2). Gaab and Seitz (1988) conclude that instability arises from the short-run adjustment processes, the long-run elasticities of income and the interest rate, respectively, showing a more stable behaviour over time.

MONEY DEMAND FUNCTIONS, as used in macroeconomic theory and in applications to monetary policy, have their theoretical underpinnings in models of portfolio optimization for the individual wealth holder. The use of these functions in an aggregative framework, in the absence of specific premises regarding aggregation, suggests the assumption that all cash holders respond in a uniform way to the same set of variables. Such an assumption is open to question. Separable categories of decision makers can be defined and cash holding behavior may vary across categories. For instance, households, non-financial firms and financial institutions may all determine their demands for cash according to the fundamental principles embodied in the standard portfolio models, but attempts to capture this behavior in money demand functions could properly involve the use of different explanatory variables and structural relations for each sector. Put another way, predictions of the aggregate amount of money demanded based on separate functions for each sector could be more accurate than those based on a single aggregative function. Little attention has been paid to this problem in the extensive literature on the demand for money. The small number of hypotheses that are widely used to generate aggregate money demand functions suggests that it is not difficult to evaluate the empirical importance of the problem. That is, functions considered useful at the aggregate level can be tested at the sectoral level. As well as subjecting these hypotheses to the standard statistical tests on data for a particular sector, their performance can be compared to that of money demand functions that reflect specific sectoral characteristics. The thesis abstracted here reports on such an analysis for the non-financial business sector. Quarterly data on manufacturing corporations in the U.S., from 1947 to 1963, were for the study. A priori suspicions turned out to be justified. Two forms of money demand functions widely accepted at the aggregate level, those based on the permanent income hypothesis and the wealth hypothesis, performed badly on this set of data. The third and simplest of the commonly used hypotheses, that money demand depends on income and the interest rate, fared somewhat better, but not as well as those functions that incorporated additional hypotheses specifically relevant to the firm. The latter hypotheses are based on the argument that the portfolio models normally used to determine optimal cash balances involve an array of assets that is too narrowly defined to represent the firm's behavior. The firm's 'portfolio' involves a complex balance sheet. Thus, the rates of return on assets and liabilities other than the standard marketable ones (e.g., accounts receivable and payable, inventories, bank loans and bonded debt), along with other variables that relate the firm's cash flow to its income flow, are considered in the analysis as well.