Demand for Money

Chapter 8

THE

DEMAND

FOR

MONEY

STEPHEN M. GOLDFELD

Princeton University
DANIEL E. SICHEL*

Board of Governors of the Federal Reserve System

Contents

1. 2.

Introduction Overview of empirical difficulties
2.1. 2.2. U.S. money demand Money demand: International evidence A brief theoretical overview A variable-by-variable review Money demand and the partial adjustment mechanism Criticisms and modifications of the partial adjustment model Dynamic models that impose long-run relationships Simultaneity, exogeneity, and the nature of the adjustment process

3.

Re-examining the basic specification
3.1. 3.2.

300 302 302 306 308
308

4.

Econometric issues
4.1. 4.2. 4.3. 4.4.

5. Concluding remarks References

313 324 325 333 338 341 349 353

* We thank Benjamin Friedman for his comments. The opinions expressed are those of the authors; they do not necessarily reflect the views of the Board of Governors of the Federal Reserve System.

Handbook of Monetary Economics, Volume I, Edited by B.M. Friedman and F.H. Hahn © Elsevier Science Publishers B.V., 1990

300

S.M. Goldfeld and D.E. Sichel

I. Introduction The relation between the demand for money balances and its determinants is a fundamental building block in most theories of macroeconomic behavior. Indeed, most macroeconomic models, whether theoretical or econometric, generally ignore the rich institutional detail of the financial sector and attempt to capture financial factors via the demand and supply of money. Furthermore, the demand for money is a critical component in the formulation of monetary policy and a stable demand function for money has long been perceived as a prerequisite for the use of monetary aggregates in the conduct of policy. Not surprisingly, then, the demand for money in many countries has been subjected to extensive empirical scrutiny. The evidence that emerged, at least prior to the mid-1970s, suggested that a few variables (essentially

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