The Demand for Money in the United States, 1959.1-2013.11

Abstract

The purpose of this paper is to estimate a stable long run money demand function for the United States using monthly data from January 1959 till November 2013. The paper has three features. One, the sample includes the recent period of near-zero values of the short term interest rate. Two, the monetary aggregate that is selected is the MZM money stock, as compiled by the Saint Louis Fed. Three, the data is monthly. One crucial question that is asked is whether the interest rate variable should enter in a log functional form or not. This depends on the stability of the constrained and the unconstrained money demand functions over the whole period. When the coefficients on the scale and price level variables are constrained to be unitary the best specification is obtained by including the interest rate variable as is. When all constraints are relaxed the best specification is when the interest rate variable enters in logs. There is evidence that the imposed constraints do not hold well statistically. The main conclusion is therefore that a full log-log model of money demand is the most appropriate, although there is some evidence of non-linearity in the relation. This implies that, at very low interest rates, there is a Keynesian liquidity trap and that, consequently, monetary policy may become totally ineffective.