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The Demand For Money: Preliminary Evidence from Industrial Countries

Published online by Cambridge University Press:  19 October 2009

George G. Kaufman  and
Cynthia M. Latta
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Extract

During the past few years several money demand functions have been estimated for the United States. Although these functions may differ on the precise specification of the independent variables, most agree on their crude identity. Thus almost all functions include an income or wealth constraint and an interest rate price. Such functions have been applied exhaustively to data for various periods in United States history, both for the long run and for the short run. With few notable exceptions, the results differ more in degree than in substance. The quantity of money demanded is estimated to be a positive function of the constraint and a negative function of price. The studies have, however, overlooked an important body of possible collaborative evidence–that for other industrial countries. It may be reasonable to assume that the same basic forces underlie the demand for money in all industrial countries, it is of interest to contrast money demand functions for these countries with those obtained for the United States. This paper estimates demand functions for leading industrial countries and evaluates the results. No new theory is developed; rather, existing models are fitted to additional data to test their applicability to other countries.

Type
Research Article
Information
Journal of Financial and Quantitative Analysis , Volume 1 , Issue 3 , September 1966 , pp. 75 - 89
Copyright
Copyright © School of Business Administration, University of Washington 1966

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References

1 For example, Brunner, Karl and Meltzer, Allan H., “Predicting Velocity: Implications for Theory and Policy,” Journal of Finance, XVIII (May 1963), pp. 319–359Google Scholar; Chow, G. C., “On the Long-Run and Short-Run Demand for Money,” Journal of Political Economy, LXXIV (April 1966), pp. 111–131Google Scholar; Cohen, Bruce C. and Kaufman, George G., “Factors Determining Bank Deposit Growth by State: An Empirical Analysis,” Journal of Finance, XX (March 1965), pp. 59–70Google Scholar; Feige, Edgar L., The Demand for Liquid Assets: A Temporal Cross-Section Analysis (Englewood Cliffs, N.J.: Prentice-Hall, 1964)Google Scholar; Friedman, Milton, The Demand for Money: Same Theoretical and Empirical Results (Occasional Paper 68; New York: National Bureau of Economic Research, 1959)Google Scholar; Meltzer, Allan H., “The Demand for Money: The Evidence from the Time Series,” Journal of Political Economy, LXXI (June 1963), pp. 219–246.Google Scholar

2 The most notable exception is Friedman, who does not find interest rates significant in his statistical estimates. Friedman, op. cit., p. 3.

3 Friedman, op. cit., p. 4.

4 Data for Belgium and Japan are for 1955–63 only. West Germany is omitted because the available data are not consistent on a geographical basis for the period considered.

5 International Financial Statistics: Supplement to 1964–65, March 1965, and Supplement on Money, 1964, International Monetary Fund Since bond yields are not shown in IFS for Japan, a series reported by the Bank of Japan is used instead.

6 In cases where the Von Neumann Ratio indicated the existence of serial correlation in the residuals, the generalized least squares transformation was used to remove the bias in the estimates of the standard errors. This transformation was applied to most of the regressions for France, Sweden, the United Kingdom and the United States.

7 How much of the poor performance of the United States is attributable to differences between the IMF and the Federal Reserve System money supply series warrants further investigation. The IMF series is based on month-end data, while the Federal Reserve data are averages of daily figures and include deposits of foreign businesses, individuals and banks.

8 For a detailed description of European money markets, see U. S. Congress, Joint Economic Committee, “A Description and Analysis of Certain European Capital Markets,” Paper No. 3 of Economic Policies and Practices, 88th Cong., 2nd Sess., 1964.

9 It also seems reasonable to assume that, at first approximation, the more developed is the financial center, the smaller are total money holdings in relation to income. That is, the Marshallian k may be expected to vary inversely with the state of development of the money market. This inference is not supported by the data, however of the nine countries examined, the United Kingdom had the highest k while Canada and the Netherlands had the lowest. All three countries have well developed money markets. This suggests that many other factors besides the state of development of the money market importantly account for the particular level of k in any country.

10 Ritter, Lawrence S., “The Structure of Financial Markets, Income Velocity, and the Effectiveness of Monetary Policy,” Schweizerische Zeitschrift fur Volkswirtschaft und Statistik (September 1962), pp. 276–289.Google Scholar

11 Meltzer, op. cit., p. 225; Cohen and Kaufman, op. cit., p. 65.

12 Meltzer, op. cit., p. 236. The only published, estimates for. hear unity income elasticities obtained from postwar time series data of which the authors are aware are reported by Hellert, H. R.Heller, H. R., “The Demand for Money: The Evidence from the Short-Run Data,” Quarterly Journal of Economics, LXXIX (May 1965), pp. 291–303Google Scholar. Attempts to replicate his results, however, resulted in the discovery of an error in the computation of the coefficients. Corrected estimates yield income elasticities similar to the low estimates reported in this paper.

While this paper only notes and, does, not explain, the apparent inconsistency between the results from postwar time series and cross-section, such inconsistencies may not be unusual., Kuh demonstrates, that there is some tendency for elasticities obtained from time series to be less than those obtained from cross-sections, for the same, period. Kuh, Edwin, “The Validity of Cross-Sectionally Estimated Behavior Equations in Time Series Applications,” Ecnometrica, XXVII (April 1959), pp. 197–214.Google Scholar

It may also be possible that at least part of the discrepancy observed between the income elasticities estimated for the United States from long run and postwar time series may be attributed to the same inverse relationship between income elasticity and. state “of development of the money market, as was noted among selected-countries. Thus, income, elasticity may have declined through time as the financial sector increased in sophistication, so, that the estimated values from long run time series represent in part the average, of, a secularly declining elasticity. While preliminary estimates by the authors indicate some decline in income elasticity in major peace-time subperiods since 1919, the short-term estimates remain well below the long-term.estimates. Chow reports similar findings and explains this behavior primarily in terms of the time lag required for full adjustment. Chow, op. cit., pp. 117–18.

13 Sprinkel, Beryl W., “Relative Economic Growth Rates and Fiscal-Monetary Policies,” Journal of Political Economy, LXXI (April 1963), PP. 154–159.CrossRefGoogle Scholar