In the last two decades there have been numerous attempts to model the demand for money in a single-equation context. This study critically examines some of the approaches which have been suggested by applied economists. One bewildering aspect of the current literature on modelling monetary aggregates is the wild diversity of the approaches which have been advocated. Using recent developments in applied the econometrics literature, we categorise and examine the various ways in which one may construct a model which appropriately characterises the long-run and the short-run demand for money. In the first part of the study (Chapters 2 and 3) we assess the various methods by which one may construct what have often been called 'feedback-only' single-equation models of the demand for money. We show that different approaches can sometimes lead the applied economist to surprisingly different conclusions about the properties of the demand for money. In the second part of the study (Chapters 4 and 5) we focus on a different approach to modelling the demand for money, which treats the decision by economic agents to hold money as a forward-looking one. This approach is based on a view of the money stock as a 'buffer asset' in economic agents' portfolios. We demonstrate how existing single-equation models may be extended in order to render them applicable in the context of a multi-asset model with saving flows. We also consider which interpretation of the demand for money (i. e. 'feedback' or 'forward-looking') is likely to be valid in the case of the Ml aggregate in the United Kingdom. Finally, in Chapter 6 we examine the way in which the presence of forward-looking behaviour in the money market may affect the role and usefulness of monetary aggregates as information variables or indicators of monetary policy.
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Feedback and forward-looking models of the demand for money: the case of the United Kingdom 1963-86
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