The Instability of the Money Demand Function: An I(2) Interpretation

Authors: Fiess, Norbert¹; MacDonald, Ronald¹

Source: Oxford Bulletin of Economics and Statistics, Volume 63, Number 4, September 2001 , pp. 475-495(21)

Publisher: Blackwell Publishing

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Abstract:

Some studies have suggested that although money and prices appear to be I(2) processes, real money balances are I(1) and this transformation preserves an important long-run relationship between money and prices. In this paper we present evidence indicating that the success of such a nominal-to-real transformation depends upon the particular monetary aggregate under consideration. It turns out that imposing long-run price homogeneity does not remove all I(2) components from a model of aggregate broad UK M4, but it does prove successful in the case of sectoral components of M4. Since recent research on money demand functions finds more stable relationships between sectoral components of M4 and aggregate demand, our analysis seems to point to a direct link between the existence of I(2) components and the stability of different money demand functions.

Document Type: Original article

DOI: 10.1111/1468-0084.00230

Affiliations: 1: Department of Economics, University of Strathclyde, Glasgow, UK

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