Money Demand Function Research Paper

Since the 1930s, economists have developed the theory underlying the demand for money along several different lines, each of which provides different answers to the basic question: „what determines the demand for real money balances”? Starting from regressive expectations model of Keynes and Tobin‟s portfolio approach, money demand function has been examined by incorporating varying influential factors. During the 1960s M. Friedman gave a new impetus to monetarism and redefined money demand function in his seminal paper on restatement of quantity theory of money in 1966. Apart from functional specification, several other dimensions of money demand functions like stability, expectation and adjustment mechanisms are explored as well. Empirical

Most of these literatures are concerned with the existence of a stable money demand function. Notable references are Friedman and Schwartz (1991), McNown and Wallace (1992), Stock and Watson (1993), Ball (2001), and Anderson and Rasche (2001). Friedman and Schwartz (1991) have argued that the underlying characteristics of the money demand function rarely change over a long period of time. In the long run, the money demand function depends mainly on macroeconomic variables, such as interest rate, real income, and, in an open economy, exchange rates, may be cointegrated and have a stable long-run equilibrium relation. Generally cointegration analysis of Granger and Engle (1987) and error correction model are employed to determine long run stable equilibrium relationship and short run dynamics of money demand function respectively. Using cointegration approaches, many studies have investigated the long-run equilibrium relationship of money demand functions. For example, Hafer and Jansen (1991), Baba et al. (1992), MacDonald and Taylor (1992), and Arize (1994), who investigated the stability of the money demand function of USA and used methods proposed by Engle and Granger (1987) and Johansen (1988). But underlying assumption of this ECM is symmetrical impact of the error component or adjustment process toward equilibrium is symmetric. But in these works asymmetric properties of the adjustment process in money demand function has not been taken into account. Enders and Granger (1998) and Enders and Siklos (2001) proposed the asymmetrical TAR and M-TAR cointegration tests.Very few empirical works are conducted in this line for developing countries like Brazil. Meng-Nan Zhu et. al.(2011) made their maiden contribution for analyzing asymmetric ECM for money demand function few developing nations. So this piece of work is a fresh attempt to empirically analyze asymmetric ECM for Brazilian