bain_y_howells__monetary_economics__policy_and_its_theoretical_basis

• The expected change in the rate of interest
• An index of prices.
TESTING THE DEMAND FOR MONEY 133
Unfortunately, we can immediately see several practical difficulties
associated with testing any equation derived from this list. These are summarized
in Box 6.1. We consider each of them below. However, we must
first mention a more general problem. Where we are required to make
choices regarding the form of the variables to be included in the testing
equation (for example, among different definitions of money), we shall see
that theory provides little or no help. This usually results in the choice being
made on pragmatic grounds — which form of the variable ‘tests better’.
But what does this mean? It means that we do not ask whether the demand
for money is stable. Rather we ask how we can construct a demand for
money function that appears to be stable over a particular period. The presumption
of almost all of the thousands of tests that have been conducted
over the past half-century has been that the demand for money is stable.
Equations that don’t produce the right result are discarded. The proposition
can never be disproved because there are always changes that can be made
to the equation being tested or new tests to be conducted. It is a rigged
game. Still, let us do as we promised and look at each of the difficulties separately.
Box 6.1: Problems in the testing of the demand for money
(a) There is no agreed definition of money for testing purposes;
(b) The demand for money is not directly observable;
(c) The assumption of an endogenous money supply creates an identification
problem;
(d) There are problems in the choice between income and wealth as the scale
variable and difficulties in the measurement of wealth;
(e) There are problems with the selection of the interest rates;
(f) Variables, all of which should be included as independent variables may
be correlated with each other, making it difficult to isolate the specific relationship
between each variable and the demand for money;
(g) Some of the variables in our list may not be easily measured or measurable at
all;
(h) There are problems in the choice of time period for the testing.