Instability versus dynamics: A study in West German demand for money

Abstract This paper presents an empirical analysis of the demand for money in Germany covering the period of 1964–1984. Money demand is specified in terms of the income velocity of money, and the openness of the German economy is taken into account in the formulation of the basic model. Using quarterly data for both narrow and broad definitions of money stocks, it is shown that the empirical evidence is consistent with the presumption of a fixed coefficient, stable demand for money function in Germany. The instability results of previous studies are likely to stem from the conventional research strategy of straightforwardly estimating a level cumstock adjustment model without taking much care of its adequacy for the relevant data generating processes. In contrast, the research strategy adopted in this paper is to carefully single out an acceptable statistical representation of the data generating process. Tests of economic hypotheses and parameter stability are conducted on the basis of this representation in the second step of our investigation.