Estimating Money Demand

Central European University

Estimating Money Demand

Case Studies: Mexico, Norway and Singapore

Ledian Asllani, Anna B. Kis, Andras Borsos, Aron Iker

March 9, 2015

Outline

Introduction        

Analysis country by country        

Mexico        

Norway        

Singapore        

Comparing country results        

References        

Appendix        

Mexico        

Johansen method        

Norway        

Engle-Granger, short run cointegrating relationship, automatic model selection, 1996-2005        

Johansen method, 1996-2007        

Johansen method, 2007-2012        

Singapore        

Johansen method        

Introduction

Monetary policy can have a great effect on the economy by dampening cycle effects or at least eliminating itself as a possible source of macroeconomic volatility. One of its common tools is to set the money supply as an adequate response to changes in money demand. Nevertheless, in order to do so, macroeconomists need reliable estimations on money demand.

The standard money demand formula can be written as M=P*L(Y,R) where M denotes nominal amount of money demanded, P stands for price level, Y is real output, R is the nominal interest rate and L(.) can be interpreted as some kind of liquidity preference function. Or alternatively, in quantitative theory of money (which is another basic approach) the formula is written as M*V=P*Y, where V is velocity of money. The common feature of the two approaches is that in case of stable money velocity or liquidity preferences, the money demand can easily be estimated. At least, this seemed to be the case until the mid-70s when due to the massive financial innovations (technological developments, financial deregulations, new types of assets), money demand became highly unstable. Since data for our chosen countries (Mexico, Norway and Singapore) are available mainly after the 80’s, our goal cannot be to get results relevant for policy purposes but to illustrate how money demand estimation may be conducted in practice.