Further search for the missing money

Mohammadreza Shojaeddini

ISU General Staff Papers from Iowa State University, Department of Economics

Abstract: The conventional form of the demand function for money worked very well in the past. However, since 1974 this function has failed to predict the public's demand for the money stock within a reasonable range of error. More specifically, since 1976 the conventional equation has overpredicted the actual quantity of money demanded. Although the Federal Reserve's newly defined monetary aggregates generally have better prediction performance than the old M-1, they show a systematic overprediction of money stock for the period of 1974:1-1980:3, the out-of-sample period in this study. The cumulative percentage errors of prediction of these new aggregates are still large and increasing in absolute value for this period. Respecifying the conventional demand function for money to include the time variable among its explanatory variables and redefining the monetary aggregate to contain overnight repurchase agreements reduced the absolute value of the percentage errors considerably. Moreover, the percentage errors of the above specification are relatively stable after 1975. That is, the percentage errors of this specification show an upward trend over the period of 1974:1-1975:4 and become stable after 1975;In the 1970s, some important institutional changes--such as authorization of telephone transfers from savings to demand deposits, preauthorized transfer of funds from savings to demand deposits, bill paying services, overdraft credit line, and automatic payroll deposits--occurred. Some wider monetary aggregates are defined to take some of these and other qualitative changes into account. Among these wider aggregates, an aggregate defined as some of M-1B, overnight RPs issued by commercial banks, overnight Eurodollar deposits at Caribbean branches of U.S. banks held by U.S. nonbank residents, money market mutual fund shares, one third of savings deposits at thrift institutions and 2/3 of savings deposits at commercial banks gave the best prediction results. The percentage errors of prediction for this aggregate are generally less than two percent.

Date: 1982-01-01
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