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Long-Run Demand for M1

  • Scott Hendry

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.

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Paper provided by EconWPA in its series Macroeconomics with number 9511001.

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Length: 70 pages
Date of creation: 27 Nov 1995
Date of revision:
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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  1. Johansen, Soren, 1988. "Statistical analysis of cointegration vectors," Journal of Economic Dynamics and Control, Elsevier, vol. 12(2-3), pages 231-254.
  2. Breedon, F J & Fisher, P G, 1996. "M0: Causes and Consequences," The Manchester School of Economic & Social Studies, University of Manchester, vol. 64(4), pages 371-87, December.
  3. David F. Hendry & Neil R. Ericsson, 1990. "Modeling the demand for narrow money in the United Kingdom and the United States," International Finance Discussion Papers 383, Board of Governors of the Federal Reserve System (U.S.).
  4. Jeroen J.M. Kremers & Neil R. Ericsson & Juan J. Dolado, 1992. "The power of cointegration tests," International Finance Discussion Papers 431, Board of Governors of the Federal Reserve System (U.S.).
  5. Yash P. Mehra, 1992. "In search of a stable, short-run M1 demand function," Economic Review, Federal Reserve Bank of Richmond, issue May, pages 9-23.
  6. Gregory D. Hess & Christopher S. Jones & Richard D. Porter, 1994. "The predictive failure of the Baba, Hendry and Starr model of the demand for M1 in the United States," Finance and Economics Discussion Series 94-34, Board of Governors of the Federal Reserve System (U.S.).
  7. Paquet, A., 1994. "A Guide to Applied Modern Macroeconometrics," Working Papers-Department of Finance Canada 1994-5, Department of Finance Canada.
  8. Werner GAAB & Olaf LIEDTKE, 1992. "On the long-run Relationship Between Money, Output and Interest Rates : A Cointegration Analysis for West Germany," Discussion Papers (REL - Recherches Economiques de Louvain) 1992045, Université catholique de Louvain, Institut de Recherches Economiques et Sociales (IRES).
  9. Denis Kwiatkowski & Peter C.B. Phillips & Peter Schmidt, 1991. "Testing the Null Hypothesis of Stationarity Against the Alternative of a Unit Root: How Sure Are We That Economic Time Series Have a Unit Root?," Cowles Foundation Discussion Papers 979, Cowles Foundation for Research in Economics, Yale University.
  10. Cheung, Yin-Wong & Lai, Kon S, 1993. "Finite-Sample Sizes of Johansen's Likelihood Ration Tests for Conintegration," Oxford Bulletin of Economics and Statistics, Department of Economics, University of Oxford, vol. 55(3), pages 313-28, August.
  11. Bardsen, Gunnar, 1992. "Dynamic modeling of the demand for narrow money in Norway," Journal of Policy Modeling, Elsevier, vol. 14(3), pages 363-393, June.
  12. Freedman, C, 1983. "Financial Innovation in Canada: Causes and Consequences," American Economic Review, American Economic Association, vol. 73(2), pages 101-06, May.
  13. Engle, Robert F & Granger, Clive W J, 1987. "Co-integration and Error Correction: Representation, Estimation, and Testing," Econometrica, Econometric Society, vol. 55(2), pages 251-76, March.
  14. Alain Paquet, 1994. "A Guide to Applied Modern Macroeconometrics," Documents techniques CREFE / CREFE Technical Papers 1, CREFE, Université du Québec à Montréal.
  15. Lucas, R.F. & Haug, A.A., 1992. "Long-Run Money Demand in Canada: In Search of Stability," Papers 92-4, Saskatchewan - Department of Economics.
  16. Mosconi, Rocco & Giannini, Carlo, 1992. "Non-causality in Cointegrated Systems: Representation Estimation and Testing," Oxford Bulletin of Economics and Statistics, Department of Economics, University of Oxford, vol. 54(3), pages 399-417, August.
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