The Stability of Money Demand Function in Five Major Industrial Countries: Evidence from Cointegration Tests

Madhusudan Ghosh
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Madhusudan Ghosh: Visva-Bharati, Santiniketan

Indian Economic Review, 2000, vol. 35, issue 2, 175-192

Abstract: Using a variety of cointegration tests, this paper examines the existence of long-run equilibrium relationship in the demand function for real M1 money balance and the possibility of structural shift in the relationship in five major industrial countries. The exercise based on the maximum likelihood tests of cointegration offers strong evidence for long run equilibrium in the money demand function with short-term as well as long-term interest rate specifications in the U.S., U.K. and Canada. For Japan, the long-term interest rate specification yields more robust results than those with the short-term interest rate. The tests offer no conclusive evidence about the specification and existence of a stable long-run money demand function for Germany. The exercise also reveals significant cross-country variations in the magnitudes of real income elasticity and interest rate semi-elasticity over the specifications of the money demand function with respect to interest rates. The study offers no evidence of significant structural break in the long-run money demand function. Contrary to the recommendation of some earlier research, the results of this study suggest that the demand function for the narrowly defined monetary aggregate can be used in the formulation of monetary policy in most of the selected countries.

JEL-codes: C32 E41 E52 (search for similar items in EconPapers)
Date: 2000
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