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

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...

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Bibliographic Details
Published in:Oxford bulletin of economics and statistics 2001-09, Vol.63 (4), p.475-495
Main Authors: Fiess, Norbert, MacDonald, Ronald
Format: Article
Language:English
Subjects:
Demand
Demand curves
Demand for money
Economic models
Economics
Monetary theory
Statistical analysis
Statistical methods
Studies
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Summary: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.
ISSN:0305-9049
1468-0084
DOI:10.1111/1468-0084.00230