《货币经济学》课程文献阅读：Money Demand as a Buffer Stock（Miller,1990）.pdf

STEPHEN M. MILLER Disequilibrium Macroeconomics, Money as a buffer stock and the Estimation of Money demand ard explanations of the seeming instability of the money demand in the post period usually link to stories about financial innovation and deregulation. I se an alternative hypothesis: Much of the seeming instability occurs because of shifts in monetary policy, either explicit or implicit, in an environment where the Federal Reserve controls a ey stock, My econometric analysis modifies existing methods for estimating markets in disequilibrium and in corporates newly developed cointegration and error-correction modeling. My find ings provide support for the buffer-stock interpretation of the money market 1. Introduction Students of macroeconomic theory are familiar with the recent extensive debate concerning macroeconomic modeling. A part of the debate considers disequilibrium or non-markct clearing macroeco- nomic models(Clower 1965; Patinkin 1965; Leijonhufvud 1968; and Barro and Grossman 1971, 1976), which failed to capture a signif- icant following, at least in the United States. This failure to attract much attention probably stems from the absence of convincing ar- guments for price rigidities One aspect of the disequilibrium macroeconomic literature fo- cuses on money as a buffer stock or shock absorber. Laidler(1984) surveys the theoretical bases for, and empirical analyses of, money as a buffer stock and concludes that "the theoretical basis of the The comments of F.w. Asking, D E w. Laidler, and two anonymous referees are gratefully acknowledged. This research was completed while the author was a Principal Analyst(visiting) at the Congressional Budget Office. The views expressed e mine and do not necessarily reflect those of the Congressional Budget Office ecause of their non-theory of (1079) recant thcir initial cnthu eir usefulness. Howitt(1979) Journal of Macroeconomics, Fall 1990, Vol. 12. No, 4, pp. 563-586 Copyright e 1990 by Louisiana State University Press 01640704/90/$1.50

STEPHEN M. MILLER Uniuersity of Connecticut Storrs, Connecticut Disequilibrium Macroeconomics, Money as a Buffer Stock and the Estimation of Money Demand* Standard explanations of the seeming instability of the money demand in the post- 1973 period usually link to stories about financial innovation and deregulation. I propose an alternative hypothesis: Much of the seeming instability occurs because of shifts in monetary policy, either explicit or implicit, in an environment where the Federal Reserve controls a more “exogenous” money stock. My econometric analysis modifies existing methods for estimating markets in disequilibrium and incorporates newly developed cointegration and error-correction modeling. My findings provide support for the buffer-stock interpretation of the money market. 1. Introduction Students of macroeconomic theory are familiar with the recent extensive debate concerning macroeconomic modeling. A part of the debate considers disequilibrium or non-market clearing macroeconomic models (Clower 1965; Patinkin 1965; Leijonhufvud 1968; and Barro and Grossman 1971, 1976), which failed to capture a significant following, at least in the United States. This failure to attract much attention probably stems from the absence of convincing arguments for price rigidities. r One aspect of the disequilibrium macroeconomic literature focuses on money as a buffer stock or shock absorber. Laidler (1984) surveys the theoretical bases for, and empirical analyses of, money as a buffer stock and concludes that “the theoretical basis of the *The comments of F.W. Ahking, D.E.W. Laidler, and two anonymous referees are gratefully acknowledged. This research was completed while the author was a Principal Analyst (visiting) at the Congressional Budget Office. The views expressed are mine and do not necessarily reflect those of the Congressional Budget Offrce or its statf. ‘Barr0 (1979) criticizes disequilibrium models because of their “non-theory of price rigidities.” And Barro (1979) and Grossman (1979) recant their initial enthusiasm for disequilibrium models, questioning their usefulness. Howitt (1979), in contrast, provides a more sympathetic evaluation. Journal of Macroeconomics, Fall 1990, Vol. 12, No. 4, pp. 563586 563 Copyright 0 1996 by Louisiana State University Press 0164-0704/96/$1.56

Stephen M. Miller buffer stock to monetary analysis is well developed and simple, and it has already withstood a good deal of empirical testing"(32).2 Most econt ric analyses of money demand recognize, at least implicitly, the possibility of disequilibrium. The standard stock (supply) -adjustment model (Chow 1966 and Goldfeld 1973)differ ntiates between short- and long- run demands. But this specifica- tion possesses some peculiarities if the money supply is exogenous (Walters 1965; Starleaf 1970; Artis and Lewis 1976; Laidler 1980 Carr and Darby 1981; Coats 1982; and Andersen 1985 For ex- ample, a change in the money supply requires that the interest rate, real income, and the pi level overshoot their long-run val les in the short run (Starleaf 1970 provides extensive discussion ). Judd and Scadding(1982b)compare supply- and demand-adjustin specifications, concluding that the demand-adjusting models out perform the supply-adjusting models, both for within-sample fit(that is, 1959: i to 1974: i)and for out-of-sample forecasting (that is, 1974: ii Judd and Scadding(1982b)note that even for the best-per forming equation(that is, Coats 1982 ), the out-of-sample simulation encounters the well-known shift in the demand for money in (28). Post-1973 econometric analysis of money de mand also suggests implausibly slow speeds of adjustment udd and Scadding 1982a). The emergence of high levels of autocorrelation and seeming parameter instability in the post-1973 period causes some researchers to search for model misspecifications(for example Gordon 1984 and Rose 1985). A popular explanation states that money lemand shifted down between 1974 and 1976 and again between 1979 and 1981 because of financial innovation (udd and Scadding 1982a). More recently, explanations state that money demand shifted up between 1982 and 1983(Gordon 1984; Hetzel 1984; and Miller 1986)and again between 1985 and 1986(Miller 1989)because of financial deregulation I propose a tentative alternative hypothesis to explain po 1973 events: much of the shifting of money demand reflects shifts in money supply (that is, a shift in monetary policy in the sense of Poole 1975)rather than money demand. Significant decelerations aSome authors(White 1981)question the buffer-stock approach to money,ar- guing that since money is, by definition, the most liquid and flexible asset, a dis- ey market is untenable. Such criticism, by a Examining seven industrial countries, OECD(1984)finds that the adoption of money-stock targeting associates with money demand shifts

Stephen M. Miller buffer stock to monetary analysis is well developed and simple, and it has already withstood a good deal of empirical testing” (32).’ Most econometric analyses of money demand recognize, at least implicitly, the possibility of disequilibrium. The standard stock (supply)-adjustment model (Chow 1966 and Goldfeld 1973) differentiates between short- and long-run demands. But this specification possesses some peculiarities if the money supply is exogenous (Walters 1965; Starleaf 1970; Artis and Lewis 1976; Laidler 1980; Carr and Darby 1981; Coats 1982; and Andersen 1985). For example, a change in the money supply requires that the interest rate, real income, and the price level overshoot their long-run values in the short run (Starleaf 1970 provides extensive discussion). Judd and Scadding (1982b) compare supply- and demand-adjusting specifications, concluding that the demand-adjusting models outperform the supply-adjusting models, both for within-sample fit (that is, I959:i to I974:ii) and for out-of-sample forecasting (that is, 1974:iii to 1980:iu). Judd and Scadding (198213) note that even for the best-performing equation (that is, Coats 1982), the out-of-sample simulation encounters the “. . . well-known shift in the demand for money in 1975-76 . . .” (28). Post-1973 econometric analysis of money demand also suggests implausibly slow speeds of adjustment (Judd and Scadding 1982a). The emergence of high levels of autocorrelation and seeming parameter instability in the post-1973 period causes some researchers to search for model misspecifications (for example, Gordon 1984 and Rose 1985). A popular explanation states that money demand shifted down between I974 and 1976 and again between 1979 and 1981 because of financial innovation (Judd and Scadding 1982a). More recently, explanations state that money demand shifted up between 1982 and 1983 (Gordon 1984; Hetzel 1984; and Miller 1986) and again between 1985 and 1986 (Miller 1989) because of financial deregulation. I propose a tentative alternative hypothesis to explain post- 1973 events: much of the shifting of money demand reflects shifts in money supply (that is, a shift in monetary policy in the sense of Poole 1975) rather than money demand.3 Significant decelerations ‘Some authors (White 1981) question the buffer-stock approach to money, arguing that since money is, by definition, the most liquid and flexible asset, a disequilibrium in the money market is untenable. Such criticism, by its nature, must question the modeling of the short-run money demand as well. 3Examining seven industrial countries, OECD (19&t) finds that the adoption of money-stock targeting associates with money demand shifts. 564

Disequilibrium Macroeconomics (accelerations)in money-stock growth are incorrectly interpreted as downward (upward)shifts in short-run money demand. If the shifts in money demand noted in the previous paragraph were actually shifts in monetary policy, then my hypothesis suggests contraction ary monetary policy during the first two periods and expansionary policy during the latter two. Moreover, these policy shifts need no have been planned. The first two periods correspond roughly to inflation build-ups after oil- price shocks. If oil-price shocks generate xpected inflation, then a given monetary policy becomes more contractionary (less expansionary)ex post. In addition, the latter two periods correspond to a softening of oil prices and of domestic in flation. In sum, sustained deviations of money-stock growth from its trend generate money-market disequilibria; the demand for money dusts to the new policy regime as the interest rate, real income and the price level change In the next section, I describe the econometric procedures developed for handling market disequilibria and show how these procedures can be modified to address buffer stocks in a macro- economic setting. Inferences concerning the nature of the high au- tocorrelation in post-1973 estimates of money demand emerge from this discussion. I then incorporate relatively new econometric pro- cedures, cointegration and error-correction modeling, before mov ing to my empirical analysis. Section 3 discusses the data and eval uates the estimation results. Finally, Section 4 concludes the paper 2. Methodology Estimating Markets in disequilibrium Expanding on the analysis of Fair and Jaffee(1972), a number of authors estimate markets in disequilibrium( for example, Fair and Kelejian 1974; Maddala and Nelson 1974; Laffont and Garcia 1977 and Quandt and Rosen 1978), usually the mortgage market. The key assumption asserts that, when the market is in disequilibrium the observed quantity reflects the minimum of demand and supply quantities at the given price (that is, the short-side rule). Deter ining whether a demand or supply observation occurs depends on the direction of movement in the market price. If the observed price exceeds the market-clearing level, then the price falls and the observed quantity presumably lies on the demand curve and vice ersa. Estimation of the money market in disequilibrium differs in two important respects. First, the short-side rule breaks down; the

Disequilibrium Macroeconomics (accelerations) in money-stock growth are incorrectly interpreted as downward (upward) shifts in short-run money demand. If the shifts in money demand noted in the previous paragraph were actually shifts in monetary policy, then my hypothesis suggests contractionary monetary policy during the first two periods and expansionary policy during the latter two. Moreover, these policy shifts need not have been planned. The first two periods correspond roughly to inflation build-ups after oil-price shocks. If oil-price shocks generate unexpected inflation, then a given monetary policy becomes more contractionary (less expansionary) ex post. In addition, the latter two periods correspond to a softening of oil prices and of domestic inflation. In sum, sustained deviations of money-stock growth from its trend generate money-market disequilibria; the demand for money adjusts to the new policy regime as the interest rate, real income, and the price level change. In the next section, I describe the econometric procedures developed for handling market disequilibria and show how these procedures can be modified to address buffer stocks in a macroeconomic setting. Inferences concerning the nature of the high autocorrelation in post-1973 estimates of money demand emerge from this discussion. I then incorporate relatively new econometric procedures, cointegration and error-correction modeling, before moving to my empirical analysis. Section 3 discusses the data and evaluates the estimation results. Finally, Section 4 concludes the paper. 2. Methodology Estimating Markets in Disequilibrium Expanding on the analysis of Fair and Jaffee (1972), a number of authors estimate markets in disequilibrium (for example, Fair and Kelejian 1974; Maddala and Nelson 1974; Laffont and Garcia 1977; and Quandt and Rosen 1978), usually the mortgage market. The key assumption asserts that, when the market is in disequilibrium, the observed quantity reflects the minimum of demand and supply quantities at the given price (that is, the short-side rule). Determining whether a demand or supply observation occurs depends on the direction of movement in the market price. If the observed price exceeds the market-clearing level, then the price falls and the observed quantity presumably lies on the demand curve and vice versa. Estimation of the money market in disequilibrium differs in two important respects. First, the short-side rule breaks down; the

Stephen M. Miller quantity of money observed always falls on the money supply.Sec ond, no unique price of money exists from which market-disequi libria signa Rather, money-market disequilibria generate adjustments of varying degrees and with different timing in the in terest rate, real income, and the price level. If the monetary au- thorities increase the moncy supply, then the cconomy holds too much money. Individuals reduce their holding of money by in creased spending on goods, services, and assets. If asset demands se, then interest rates fall. If goux real income and the price level rise. a consensus exists on the tim ing of these effects; the interest rate adjusts first, followed in order by real income and the price level. As the price level finally ad justs, the interest rate and real income movements attenuate; many argue that in the long run, the price level absorbs all of the ad Justment To illustrate, assume that the demand for money takes the following form In M:=o+ a,In r +aln y, agIn Pt+E, where M is the nominal quantity of money demanded, r is the market interest rate, y is real income, P is the price level, In the natural logarithm operator, and E is a random error. The de- mand is specified in nominal terms and can be written in real terms only if a3 =1. The quantity of money demanded becomes observ able only in equilibrium when it equals the money supply(M) In formulating adjustments to disequilibrium, I develop a modification of the Fair-Jaffee(1972)quantitative method. They as- ume that the market price adjusts to the difference between the quantities demanded and supplied. That is =中(Q-Q;) re is the market price of Q, Qp manded and supplied, D is the first-difference operator, and p is the speed of adjustment. Thus, if o is greater (less)than o, then q rises(falls Osagie and Osayimwese(1981)discuss the ideas of disequilibrium in the money market and how the Fair-Jaifee(1972) technique can be used to estimate the money market. They also discuss the issue of what price to use for identifying disequilibria, but assume incorrectly that the short-side rule operates. Finally, they do not pe

Stephen M. Miller quantity of money observed always falls on the money supply. Second, no unique price of money exists from which market-disequilibria signals emanate. Rather, money-market disequilibria generate adjustments of varying degrees and with different timing in the interest rate, real income, and the price level. If the monetary authorities increase the money supply, then the economy holds too much money. Individuals reduce their holding of money by increased spending on goods, services, and assets. If asset demands rise, then interest rates fall. If goods and service demands rise, then real income and the price level rise. A consensus exists on the timing of these effects; the interest rate adjusts first, followed in order by real income and the price level. As the price level finally adjusts, the interest rate and real income movements attenuate; many argue that in the long run, the price level absorbs all of the adjustment.4 To illustrate, assume that the demand for money takes the following form: ln My = u.,, + cwrln r, + cwzln yt + oaln P, + E, , (1) where MD is the nominal quantity of money demanded, r is the market interest rate, y is real income, P is the price level, In is the natural logarithm operator, and E is a random error. The demand is specified in nominal terms and can be written in real terms only if o3 = 1. The quantity of money demanded becomes observable only in equilibrium when it equals the money supply (MS). In formulating adjustments to disequilibrium, I develop a modification of the Fair-Jaffee (1972) quantitative method. They assume that the market price adjusts to the difference between the quantities demanded and supplied. That is, where q is the market price of Q, QD and Q” are quantities demanded and supplied, D is the first-difference operator, and @ is the speed of adjustment. Thus, if Q” is greater (less) than QS, then q rises (falls). 40sagie and Osayimwese (1981) discuss the ideas of disequilibrium in the money market and how the Fair-JaEee (1972) technique can be used to estimate the money market. They also discuss the issue of what price to use for identifying disequilibria, but assume incorrectly that the short-side rule operates. Finally, they do not perform any econometric tests. 566