DYNAMIC MODELING OF THE DEMAND FOR NARROW MONEY IN NORWAY

The role and stability of the demand for money are recurring issues in applied econometrics. Does a constant long-run demand for money function exist? If so, is money exogenous, and hence a policy variable, or endogenous? The notion of cointegration provides a tool for identifying long-run relationships, to be embedded in dynamic error correction models with constant parameters, while the assumed exogeneity status of variables for the parameters of interest can be assessed by recently developed tests. This paper derives a demand function for narrow money in Norway by applying these tools, starting out with a vector autoregressive representation that includes money (M1), prices, real expenditure and several interest rates. Given a sample fiddled with financial deregulation, changing monetary policy, and an economy switching its basis from industrial production towards oil exportation, one should not be surprised to find an unstable demand for money function. A conditional model with constant parameters is nevertheless established. Finally tests for weak and super exogeneity are conducted. Prices, real expenditure, and interest rates are super exogenous for the parameters of the demand for money. This means that simulation experiments can be conducted for the effects of monetary and fiscal policy on the demand for money.