The Sources of the U.S. Money Demand Instability

The structural stability of money demand relations has been the issue of a substantial number of empirical studies. In most studies for the U.S. structural breaks were found in the 1970s and the 1980s. In the present study a money demand function is specified in error-correction-form which involves real M 1, real GNP, the deflator and a short-term interest rate. Using flexible least squares it is shown for the U.S. that the long-run coefficients of M 1, GNP and the interest rate are relatively stable over a period of more than 30 years while the deflator does not enter the relation. The instability of the relation is mainly due to changes in the short-term dynamics.