Australasian money demand stability: application of structural break tests

Abstract

Estimates of the demand for money provide important foundations for monetary policy setting but if the estimation technique does not explicitly account for structural changes then such estimates will be biased. This article presents an investigation into the level and stability of money demand (M1) for Australia and New Zealand over the period 1960–2009 and demonstrates that both countries experienced regime shifts; Australia also experienced an intercept shift. Application of four time series methods provide consistent results with 1984 and 1998 break dates. Cumulative Sum (CUSUM) and CUSUMSQ stability tests reveal that M1 demand functions were unstable over the period 1984–1998 for both countries although tests for stability are not rejected thereafter.

Keywords:

• money demand
• cointegration
• structural breaks
• Australia
• New Zealand

JEL Classification::

• C22
• E41

Acknowledgements

The authors thank Prof. B. Bhaskara Rao and Peter Howells for useful comments on earlier drafts. Any error remains the authors’ responsibility.

Notes

¹ For discussions related to the theoretical developments of the demand for money see Laidler (1969, 1977, 1993a, b), Barnett et al. (1992), Bruggemann and Nautz (1997), Serletis (2001) and Duca and van Hoose (2004).

² Other studies that found no evidence of instability in money demand functions include Hayo (2000) for Austria, Juselius (1998) for Denmark, Nielsen et al. (2004) for Italy, Bahmani-Oskooee and Economidou (2005) for Greece, Gerlach-Kristen (2001) for Switzerland, and Nielsen (2004) and Escribano (2004) for the UK.

³ On a policy front, Papadopoulos and Zis (1997) are doubtful whether a monetary rule can provide an efficient anti-inflation policy framework.

⁴ Many central banks, including the Reserve Bank of Australia and Reserve Bank of New Zealand, find it relatively easy to control M1 and therefore testing for the stability of M1 demand offers useful implications on monetary policy procedures. Although either nominal or real exchange rate can be used to proxy for the cost of holding money, we have used real effective exchange rate due to data availability. Our results are based on the application of the GDP deflator to compute the inflation rate although application of the Consumer Price Index (CPI) gave qualitatively similar results.

⁵ Using annual data our dataset is balanced and consequently there are no gaps in the series. Selecting monthly or quarterly data would have resulted in attaining data from 1990 onwards and it would have been difficult to analyse the impact of reform policies implemented during 1980s.

⁶ See Laidler (1993a, b), Sriram (1999) and Hoffman and Rasche (2001) for surveys of long run elasticities of money demand.

⁷ GH developed the critical values by modifying the MacKinnon (1991) procedure.

⁸ We disregarded the estimates of other models for both countries because they are either statistically insignificant or have implausible income elasticity magnitudes. The canonical specification failed to explain the determinants of money demand for New Zealand, leading us to prefer the extended version.

⁹ We only considered break dates of those models which reveal the existence of cointegration.

¹⁰ See Kumar et al. (2012a, b) and Rao (2007) for details on alternative time series methods.

¹¹ See Taylor (1986) and Rao et al. (2010) for an overview and strengths of the GETS technique.

¹² The χ ² statistics indicate that there are no diagnostic test issues associated with serial correlation (), functional form misspecification (), nonnormality () or heteroscedasticity () in the residuals; hence, the short run dynamic results are well-determined and robust.