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The Short-Run Demand for Money: A Reconsideration

  • Gordon, Robert J

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 such independent variables 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 level is subject to gradual adjustment but 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 model, 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, but rather a mixture of demand and supply responses.

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Paper provided by C.E.P.R. Discussion Papers in its series CEPR Discussion Papers with number 24.

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Date of creation: Jul 1984
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Handle: RePEc:cpr:ceprdp:24
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  1. Robert J. Gordon, 1981. "Output Fluctuations and Gradual Price Adjustment," NBER Working Papers 0621, National Bureau of Economic Research, Inc.
  2. Meade, James E, 1993. "The Meaning of "Internal Balance."," American Economic Review, American Economic Association, vol. 83(6), pages 3-9, December.
  3. Milton Friedman, 1959. "The Demand for Money: Some Theoretical and Empirical Results," NBER Chapters, in: The Demand for Money: Some Theoretical and Empirical Results, pages 1-29 National Bureau of Economic Research, Inc.
  4. Brunner, Karl & Meltzer, Allan H., 1980. "On the state of macroeconomics," Carnegie-Rochester Conference Series on Public Policy, Elsevier, vol. 12(1), pages 1-5, January.
  5. Bean, Charles R, 1983. "Targeting Nominal Income: An Appraisal," Economic Journal, Royal Economic Society, vol. 93(372), pages 806-19, December.
  6. 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.
  7. Granger, C. W. J. & Newbold, P., 1974. "Spurious regressions in econometrics," Journal of Econometrics, Elsevier, vol. 2(2), pages 111-120, July.
  8. Rose, Andrew K, 1985. "An Alternative Approach to the American Demand for Money," Journal of Money, Credit and Banking, Blackwell Publishing, vol. 17(4), pages 439-55, November.
  9. Coats, Warren L, Jr, 1982. "Modeling the Short-Run Demand for Money with Exogenous Supply," Economic Inquiry, Western Economic Association International, vol. 20(2), pages 222-39, April.
  10. 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.
  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, vol. 4(4), pages 637-660, November.
  12. Robert E. Hall, 1983. "Macroeconomic policy under structural change," Proceedings - Economic Policy Symposium - Jackson Hole, Federal Reserve Bank of Kansas City, pages 85-122.
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