Monetary dynamics, exchange rates and parameter instability: an empirical investigation

This paper examines the existence and stability of both the long‐ and short‐run demand for narrow and broad money balances. The data for Singapore are used as a case study. The quarterly period examined is 1973:2‐1999:3 (105 observations). The study reveals the existence of a systematic long‐run relationship among real money balances, real income, interest rate and exchange rate. Results from testing the hypothesis of a unitary price elasticity confirm that only the broad money aggregate could be used as intermediate target of monetary policy. Using a formal test of parameter constancy designed specifically for cointegrating vectors, it is shown that nonstationarity and time invariance in the demand for money can be resolved by the inclusion of the exchange rate.