Adjustment costs and nonlinear dynamics in the demand for money: Italy, 1861-1991

Abstract

Target-bounds models and buffer stock models in the presence of adjustment costs imply nonlinear functional forms for the aggregate demand for money characterized by smooth adjustment towards long-run equilibrium. This paper presents a stable empirical model for the demand for narrow money in Italy using high quality annual data spanning from Italian unification in 1861 through to 1991. A unique, theory consistent long-run function is obtained jointly with the short-run dynamic demand function by estimating a nonlinear error correction model in the form of an exponential smooth transition regression. The model proposed variance-dominates, encompasses and fits better than various linear and nonlinear alternative specifications. Copyright © 1999 John Wiley & Sons, Ltd.

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