The Search for a Stable Money Demand Function: A Survey Of the Post-1973 Literature

Abstract

PHE QUESTION of whether the demnand function for money is is one of the most important recurring issues in the theory and application of macroeconomic policy. What is being sought in a stable demand function is a set of necessary conditions for money to exert a predictable influence on the economy so that the central bank's control of the money supply can be a useful instrument of economic policy. As such, the notion of a stable demand function appears to involve three key elements (e.g.: John T. Boorman, 1976, p. 317 and David E. W. Laidler, 1977, pp. 34-35). First, the demand for money relation should be highly predictable in a statistical sense as measured by the usual goodness-of-fit statistics, precision of estimated coefficients and (presumably) its ability to forecast accurately out of sample. Second, a stable demand function for money has relatively few arguments; a relationship that requires knowledge about a large number of variables in order to pin it down is, in effect, not predictable. Finally, the variables that appear as arguments in the function should represent significant links to spending and economic activity in the real sector. In sum, a stable demand function for money means that the quantity of money is predictably related to a small set of key variables linking money to the real sector of the economy. The importance of a stable money demand function for monetary policy can be illustrated with the standard IS-LM model, in which interest rates and GNP are the endogenous variables. In this context, a stable demand function for money translates into a well-defined relationship between money, interest rates and GNP

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