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The Short-Run Demand for Money: A Reconsideration

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  • Robert J. Gordon

Abstract

The partial-adjustment approach to the specification of the short-run demand for money has dominated the literature for more than a decade. There are three basic problems with this approach. First, the same lag structure is imposed on all variables, and each independent variable enters only as a current value. In contrast a rational individual would respond to different variables (income, interest rates, prices) with quite different lags. Second, when the general price levelis subject to gradual adjustment hut can move quickly in response to supply shocks, the influence of these supply shocks should enter with a negative sign. Third, the estimated equation for real balances may not be a money demand equation at all, but rather its coefficients may represent a shifting mixture of demand and supply responses.The empirical work examines several alternative dynamic specifications, including a generalized partial adjustment framework and the error-correction model. Both of the latter specifications exhibit greater structural stability after 1973 than the standard partial adjustment specification, and the generalized partial adjustment model also yields relatively small errors in post-sample dynamic simulations. Shifts in coefficients as the sample period is extended after 1973 are consistent with the interpretation that the real balance equation no longer traces out structural demand parameters, hut rather a mixture of demand and supply responses.

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Paper provided by National Bureau of Economic Research, Inc in its series NBER Working Papers with number 1421.

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Date of creation: Aug 1984
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Publication status: published as Gordon, Robert J. The Short-Run Demand for Money: A Reconsideration." Journal of Money, Credit and Banking, Vol. 16, No. 4, Part 1, (November 1984),pp. 403-434.
Handle: RePEc:nbr:nberwo:1421

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  1. Bean, Charles R, 1983. "Targeting Nominal Income: An Appraisal," Economic Journal, Royal Economic Society, Royal Economic Society, vol. 93(372), pages 806-19, December.
  2. Cooley, Thomas F & LeRoy, Stephen F, 1981. "Identification and Estimation of Money Demand," American Economic Review, American Economic Association, vol. 71(5), pages 825-44, December.
  3. Coats, Warren L, Jr, 1982. "Modeling the Short-Run Demand for Money with Exogenous Supply," Economic Inquiry, Western Economic Association International, Western Economic Association International, vol. 20(2), pages 222-39, April.
  4. Milton Friedman, 1959. "The Demand for Money: Some Theoretical and Empirical Results," NBER Books, National Bureau of Economic Research, Inc, number frie59-1, January.
  5. Meade, James E, 1993. "The Meaning of "Internal Balance."," American Economic Review, American Economic Association, vol. 83(6), pages 3-9, December.
  6. Rose, Andrew K, 1985. "An Alternative Approach to the American Demand for Money," Journal of Money, Credit and Banking, Blackwell Publishing, Blackwell Publishing, vol. 17(4), pages 439-55, November.
  7. Barro, Robert J, 1977. "Unanticipated Money Growth and Unemployment in the United States," American Economic Review, American Economic Association, vol. 67(2), pages 101-15, March.
  8. Robert J. Gordon, 1981. "Output Fluctuations and Gradual Price Adjustment," NBER Working Papers 0621, National Bureau of Economic Research, Inc.
  9. Brunner, Karl & Meltzer, Allan H., 1980. "On the state of macroeconomics," Carnegie-Rochester Conference Series on Public Policy, Elsevier, Elsevier, vol. 12(1), pages 1-5, January.
  10. Robert E. Hall, 1983. "Macroeconomic policy under structural change," Proceedings - Economic Policy Symposium - Jackson Hole, Federal Reserve Bank of Kansas City, Federal Reserve Bank of Kansas City, pages 85-122.
  11. Plosser, Charles I. & Schwert*, G. William, 1978. "Money, income, and sunspots: Measuring economic relationships and the effects of differencing," Journal of Monetary Economics, Elsevier, Elsevier, vol. 4(4), pages 637-660, November.
  12. Granger, C. W. J. & Newbold, P., 1974. "Spurious regressions in econometrics," Journal of Econometrics, Elsevier, Elsevier, vol. 2(2), pages 111-120, July.
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Cited by:
  1. Martin B. Schmidt, 2004. "Exogeneity within the M2 Demand Function: Evidence from a Large Macroeconomic System," Economic Inquiry, Western Economic Association International, Western Economic Association International, vol. 42(4), pages 634-646, October.
  2. Hendry, David F. & Ericsson, Neil R., 1991. "Modeling the demand for narrow money in the United Kingdom and the United States," European Economic Review, Elsevier, vol. 35(4), pages 833-881, May.
  3. Yu Hsing, 2007. "Currency Substitution, Capital Mobility and Functional Forms of Money Demand in Pakistan," Lahore Journal of Economics, Department of Economics, The Lahore School of Economics, Department of Economics, The Lahore School of Economics, vol. 12(1), pages 35-48, Jan-Jun.
  4. Erwin W. Heri, 1988. "Money Demand Regressions and Monetary Targeting Theory and Stylized Evidence," Swiss Journal of Economics and Statistics (SJES), Swiss Society of Economics and Statistics (SSES), Swiss Society of Economics and Statistics (SSES), vol. 124(II), pages 123-149, June.
  5. Martin Schmidt, 2007. "The long and short of money: short-run dynamics within a structural model," Applied Economics, Taylor & Francis Journals, Taylor & Francis Journals, vol. 40(2), pages 175-192.
  6. Tin, Jan, 1999. "Short-run and long-run demand for financial assets A microeconomic perspective," International Review of Economics & Finance, Elsevier, vol. 8(4), pages 467-478, November.
  7. Schmidt, Martin B., 2001. "The long and short of money and prices: a market equilibrium approach," Journal of Economics and Business, Elsevier, Elsevier, vol. 53(6), pages 563-583.
  8. Martin Schmidt, 2003. "Money and prices: evidence from the G7 countries," Applied Economics, Taylor & Francis Journals, Taylor & Francis Journals, vol. 35(17), pages 1799-1809.
  9. Martin Schmidt, 2003. "Monetary dynamics: a market approach," Applied Economics, Taylor & Francis Journals, Taylor & Francis Journals, vol. 35(2), pages 139-152.
  10. Issing, Otmar, 1997. "Monetary targeting in Germany: The stability of monetary policy and of the monetary system," Journal of Monetary Economics, Elsevier, Elsevier, vol. 39(1), pages 67-79, June.
  11. Daniel L. Thornton, 1985. "Money demand dynamics: some new evidence," Review, Federal Reserve Bank of St. Louis, issue Mar, pages 14-23.
  12. Caballero, Ricardo J. & Engel, Eduardo M. R. A., 1993. "Microeconomic rigidities and aggregate price dynamics," European Economic Review, Elsevier, vol. 37(4), pages 697-711, May.
  13. A. M. M. Jamal & Yu Hsing, 2011. "The Demand for Money in a Simultaneous-Equation Framework," Economics Bulletin, AccessEcon, vol. 31(2), pages 1929-1934.
  14. Tin, Jan, 1999. "The impacts of racial differences on demand for financial assets," International Review of Financial Analysis, Elsevier, vol. 8(3), pages 269-282, March.
  15. Grech, Aaron George, 2014. "The demand for currency in Malta," MPRA Paper 53878, University Library of Munich, Germany.
  16. Cheong, ChongCheul, 2003. "Regime changes and econometric modeling of the demand for money in Korea," Economic Modelling, Elsevier, vol. 20(3), pages 437-453, May.
  17. Darrat, Ali F. & Al-Mutawa, Ahmed, 1996. "Modelling money demand in the United Arab Emirates," The Quarterly Review of Economics and Finance, Elsevier, Elsevier, vol. 36(1), pages 65-87.
  18. Arnold, Ivo J. M., 1996. "Stochastic trends in the long-run behavior of velocity: A new test of the institutional hypothesis," Journal of Policy Modeling, Elsevier, Elsevier, vol. 18(6), pages 623-641, December.

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