bain_y_howells__monetary_economics__policy_and_its_theoretical_basis

132 MONETARY ECONOMICS
explaining the apparent instability. Most researchers have attempted to
show in one way or another that the problems were, indeed, only apparent
and did not seriously undermine the conventional theory of the demand for
money. The principal areas of endeavour have been in improving the
econometric techniques used and in studying financial innovation and its
effects on the demand for money. As well, the buffer stock theory of the
demand for money was developed to show how some of the empirical findings
could be explained within the framework of neoclassical theory. In
section 6.5, we look at views sceptical about the notion of a stable demand
for money.
6.2 Problems in testing the demand for money
We suggest in Section 4.4 that if money is endogenous, the demand for
money might not be very important. However, since much of past monetary
economics has assumed an exogenous money supply, the demand for
money has seemed central to many of the debates on the value of monetary
policy. 1 Consequently, we sufficiently felt the need to conform to past
views to spend Chapter 5 looking in some detail at the theory of the demand
for money, only to find that it raised a number of questions but did not provide
answers. In particular, the theories differed over two issues that would
be crucial if the supply of money were exogenous:
1. The extent to which the demand for money is sensitive to changes in
the rate of interest; and
2. whether the demand for money function is likely to be stable.
The only possible way of resolving these issues appeared to be through testing.
A logical starting point for this is to derive from that theory the independent
variables we wish to include in the equation to be tested. Based on
our discussion in Chapter 5, this might give us a list something like the following:
• The interest rate on representative non-money assets, possibly
including the rate of inflation
• The interest rate on money
• The transfer costs of switching between money and non-money assets
• The level of current income or wealth/permanent income
• The variance of income