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Long-Run Demand for M1

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  • Scott Hendry

Abstract

The goal of this paper is to investigate and estimate long-run relationships among M1, prices, output and interest rates, with a view to determining if there is a stable relationship that can be interpreted as long-run money demand. The paper uses a maximum-likelihood multiple- equation cointegration technique, developed by Johansen, to fit a system of equations to the data. One finding is that long-run, but not short-run, unitary price elasticity is easily accepted, while the income elasticity is close to one-half. The coefficients on the deviation of money from its long-run equilibrium in the vector error-correction model imply that when M1 is above its long-run demand, money will decrease and prices increase to restore long-run equilibrium. The effects of the deviation on output and interest rates are insignificant, pointing to the weak exogeneity of these variables. The implication of the results is that all the adjustment to return the economy to monetary equilibrium comes from fluctuations in money and prices. However, this does not preclude the possibility that changes in the stock of money may have short-run real effects. Indeed, the results suggest that changes in M1 lead short-term changes in output.

Suggested Citation

  • Scott Hendry, 1995. "Long-Run Demand for M1," Macroeconomics 9511001, EconWPA.
  • Handle: RePEc:wpa:wuwpma:9511001
    Note: 70 printed pages, compressed PostScript file. Other recent Bank of Canada working papers are listed on the last page of this report.
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    References listed on IDEAS

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    Cited by:

    1. Philip Arestis & Malcolm Sawyer, 2003. "Does the stock of money have any causal significance?," Banca Nazionale del Lavoro Quarterly Review, Banca Nazionale del Lavoro, vol. 56(225), pages 113-136.
    2. David Longworth & Brian O´Reilly, 2002. "The Monetary Policy Transmission Mechanism and Policy Rules in Canada," Central Banking, Analysis, and Economic Policies Book Series,in: Norman Loayza & Klaus Schmidt-Hebbel & Norman Loayza (Series Editor) & Klaus Schmidt-Hebbel (Series (ed.), Monetary Policy: Rules and Transmission Mechanisms, edition 1, volume 4, chapter 13, pages 357-392 Central Bank of Chile.
    3. Lubo Komrek & Martin Meleck, 2004. "Money Demand in an Open Transition Economy," Eastern European Economics, Taylor & Francis Journals, vol. 42(5), pages 73-73, September.
    4. Amir Kia, 2002. "Demand for Money, Economic Policies, and Stability," Emory Economics 0211, Department of Economics, Emory University (Atlanta).
    5. Jim Day & Ron Lange, 1997. "The Structure of Interest Rates in Canada: Information Content about Medium-Term Inflation," Staff Working Papers 97-10, Bank of Canada.
    6. St-Amant, P. & van Norden, S., 1997. "Measurement of the Output Gap: A Discussion of Recent Research at the Bank of Canada," Technical Reports 79, Bank of Canada.
    7. Ilker Domac, 2003. "Explaining and Forecasting Inflation in Turkey," Working Papers 0306, Research and Monetary Policy Department, Central Bank of the Republic of Turkey.
    8. Cote, Denise & Kuszczak, John & Lam, Jean-Paul & Liu, Ying & St-Amant, Pierre, 2006. "A comparison of twelve macroeconomic models of the Canadian economy," Journal of Policy Modeling, Elsevier, vol. 28(5), pages 523-562, July.
    9. Ivars Tillers, 2004. "Money Demand in Latvia," Working Papers 2004/03, Latvijas Banka.
    10. Atta-Mensah, J, 1996. "A Modified P*-Model of Inflation Based on M1," Staff Working Papers 96-15, Bank of Canada.
    11. Engert, Walter & Hendry, Scott, 1998. "Forecasting Inflation with the M1-VECM: Part Two," Staff Working Papers 98-6, Bank of Canada.
    12. Godbout, M.J. & Van Norden, S., 1996. "Unit-Root Test and Excess Returns," Staff Working Papers 96-10, Bank of Canada.
    13. Steven Morling, 2002. "Output Adjustment in Developing Countries: a Structural Var Approach," Discussion Papers Series 307, School of Economics, University of Queensland, Australia.
    14. Engert, Walter & Selody, Jack, 1998. "Uncertainty and Multiple Paradigms of the Transmission Mechanism," Staff Working Papers 98-7, Bank of Canada.
    15. Jeannine Bailliu & Daniel Garcés & Mark Kruger & Miguel Messmacher, 2003. "Explaining and Forecasting Inflation in Emerging Markets: The Case of Mexico," Staff Working Papers 03-17, Bank of Canada.
    16. Martha Misas A. & Enrique López E. & Luis Fernando Melo V., 1999. "La inflación desde una perspectiva monetaria: un modelo P* para Colombia," Ensayos sobre Política Económica, Banco de la Republica de Colombia, vol. 0(35), pages 5-53, Junio.
    17. Amir Kia, 2006. "Economic policies and demand for money: evidence from Canada," Applied Economics, Taylor & Francis Journals, vol. 38(12), pages 1389-1407.
    18. Georgopoulos, George J., 2006. "Estimating the demand for money in Canada: Does including an own rate of return matter?," The Quarterly Review of Economics and Finance, Elsevier, vol. 46(4), pages 513-529, September.
    19. Marie-Josée Godbout & Simon van Norden, 1997. "Reconsidering Cointegration in International Finance: Three Case Studies of Size Distortion in Finite Samples," Staff Working Papers 97-1, Bank of Canada.
    20. Mahdi Barakchian, S., 2015. "Transmission of US monetary policy into the Canadian economy: A structural cointegration analysis," Economic Modelling, Elsevier, vol. 46(C), pages 11-26.
    21. Kasumovick, M., 1996. "Interpreting Money-Spply and Interest-Rate Sgocks as Monetary-Policy Shocks," Staff Working Papers 96-8, Bank of Canada.
    22. Pierre L. Siklos & Andrew G. Barton, 2001. "Monetary aggregates as indicators of economic activity in Canada: empirical evidence," Canadian Journal of Economics, Canadian Economics Association, vol. 34(1), pages 1-17, February.
    23. Laidler, David, 1999. "The Quantity of Money and Monetary Policy," Staff Working Papers 99-5, Bank of Canada.
    24. Armour, J. & Atta-Mensah, J. & Engert, W. & Hendry, S., 1996. "A Distant-Early-Warning Model of Inflation Based on M1 Disequilibria," Staff Working Papers 96-5, Bank of Canada.
    25. Paul D. Gilbert & Lise Pichette, 2003. "Dynamic Factor Analysis for Measuring Money," Staff Working Papers 03-21, Bank of Canada.

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