Working Paper: NBER ID: w2106
Authors: Ray C. Fair
Abstract: One of the current questions in the literature on the demand for money is whether the adjustment of actual to desired money holdings is in nominal or real terms. This paper describes a simple procedure than can be used to test the nominal against the real hypothesis. The test is carried out for 27 countries. The paper also tests the structural stability of the demand for money equations and the correctness of the dynamic specification. The results are strongly in favor of the nominal adjustment hypothesis. The estimated equations are quite good in terms of the number of coefficient estimates that are of the right sign and that are significant. The equations also stand up well when tested against a more general dynamic specification. There is, however, some evidence of structural instability before and after 1973, although the instability is generally moderate. The instability does not affect the conclusion that the nominal adjustment hypothesis dominates the real adjustment hypothesis.
Keywords: money demand; nominal adjustment; real adjustment; structural stability
JEL Codes: E41; E52
Edges that are evidenced by causal inference methods are in orange, and the rest are in light blue.
| Cause | Effect |
|---|---|
| money supply (m) (E51) | desired money holdings (E41) |
| real income (y) (E25) | desired money holdings (E41) |
| interest rates (r) (E43) | desired money holdings (E41) |
| nominal lagged adjustment variable (C51) | desired money holdings (E41) |
| real lagged adjustment variable (C22) | desired money holdings (E41) |
| structural instability (before 1973) (F31) | desired money holdings (E41) |
| structural instability (after 1973) (F32) | desired money holdings (E41) |