International Evidence on Long-Run Money Demand

Luca Benati

Robert E. Lucas, Jr.

Juan Pablo Nicolini, Senior Research Economist

Warren E. Weber, Retired Economist

June 2019 | Federal Reserve Bank of Minneapolis Staff Report 587

We explore the long-run demand for M1 based on a dataset comprising 38 countries and relatively long sample periods, extending in some cases to over a century. Overall, we find very strong evidence of a long-run relationship between the ratio of M1 to GDP and a short-term interest rate, in spite of a few failures. The standard log-log specification provides a very good characterization of the data, with the exception of periods featuring very low interest rate values. This is because such a specification implies that, as the short rate tends to zero, real money balances become arbitrarily large, which is rejected by the data. A simple extension imposing limits on the amount that households can borrow results in a truncated log-log specification, which is in line with what we observe in the data. We estimate the interest rate elasticity to be between 0.3 and 0.6, which encompasses the well-known squared-root specification of Baumol and Tobin.

An earlier version of this Staff Report circulated as Working Paper 737.

Online Appendix

DOI: https://doi.org/10.21034/sr.587