International Evidence on Long-Run Money Demand

Benati, Luca; Lucas, Robert E.; Nicolini, Juan Pablo; Weber, Warren E.

doi:10.21034/sr.587

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International Evidence on Long-Run Money Demand

Abstract: We explore the long-run demand for M1 based on a dataset comprising 38 countries and relatively long sample periods, extending in some cases to over a century. Overall, we find very strong evidence of a long-run relationship between the ratio of M1 to GDP and a short-term interest rate, in spite of a few failures. The standard log-log specification provides a very good characterization of the data, with the exception of periods featuring very low interest rate values. This is because such a specification implies that, as the short rate tends to zero, real money balances become arbitrarily large, which is rejected by the data. A simple extension imposing limits on the amount that households can borrow results in a truncated log-log specification, which is in line with what we observe in the data. We estimate the interest rate elasticity to be between 0.3 and 0.6, which encompasses the well-known squared-root specification of Baumol and Tobin.

Keywords: Long-run money demand; Cointegration;

JEL Classification: E41; C32;

https://doi.org/10.21034/sr.587