Demand for cash balances in Germany: theoretical underpinnings and empirical evidence

Abstract

The purpose of this paper is to develop and test a cash-in-advance model of an open economy. Following the contribution of Bohn (1991) and using intertemporal balance of payments theory we set up a currency demand function with real consumption expenditure, the foreign interest rate and exchange rate expectations as the core explaining variables. We test the model with the aid of the econometric techniques proposed by Hylleberg, Engle, Granger and Yoo (1990) and Engle, Granger, Hylleberg and Lee (1993) relying on quarterly seasonally unadjusted data for Germany in the period 1960: 1 to 1993: 4. The findings reported in the paper support the suggestions made by the theoretical model.