Institutional Hypothesis of the Long-Run Income Velocity of Money and Parameter Stability of the Equilibrium Relationship

Baldev Raj

Journal of Applied Econometrics, 1995, vol. 10, issue 3, 233-53

Abstract: It has recently been argued that when the conventional specification of M2 income velocity is extended to include proxies for two types of institutional change, as emphasized by Bordo and Jonung (1987, 1990), corresponding to the process of monetization and increasing financial sophistication of financial developments, this extended model is stable in the sense that one can reject the null hypothesis of no cointegration against the alternative of a single cointegrating vector. There may by implications that such an equilibrium relation is a structural income velocity of money function. The evidence based on century-long data from 1880 to 1986 presented in this paper about parameter instability of the cointegrating vector of velocity with its determinants for Canada, Norway, Sweden, and the United Kingdom casts doubt on this interpretation. The evidence is based on using formal stability tests. Moreover, it has an "eyeball" support from the sequential estimates of various parameters of the cointegrating relationship including income and interest semi-elasticities. Copyright 1995 by John Wiley & Sons, Ltd.

Date: 1995
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