An Econometric Analysis of Money Demand in Taiwan, 1950-1989
Arize, A. C., American Economist
The demand for money has probably been studied more intensively than the demand for any other asset--real or financial. This interest in the demand for money is because of its central importance to both economic theory and policy. Consequently, money demand functions have been empirically estimated by many researchers for a number of industrial and developing countries.(1)
Relatively little systematic analysis of the behavior of private balances in Taiwan exists in the empirical literature. Such studies are of potential importance because inappropriate monetary policies can deprive a country of parts of the benefits of its development effort no matter how well the economic growth program is in other respects. With respect to economic development, it may seem that monetary policy is irrelevant to developing economies because of the lack of well developed financial and capital markets. However, as stressed by Gurley and Shaw (1967), and Abdi (1977), monetary policy can still play a major role in mobilizing savings into real capital and promoting financial stability; this would, in turn, contribute to the development of efficient financial and capital markets. Indeed, the government of Taiwan relied heavily on domestic monetary policies to support its export promotion policies in the 1970s and 1980s. See Liang and Liang (1988: 121-125) for a more detailed discussion.
The purpose of this study is to estimate an appropriate money demand function for Taiwan, a country which, to the best of my knowledge, has been the subject of very little economic analysis. One possible reason for this may be that data on this economy are only now becoming available. For example, quarterly data on the relevant variables are available for the period 1985 through 1988 only, whereas GNP data are available on an annual basis only. In this study, annual data are used and cover the period 1950 through 1989, that is, 40 observations.(2)
Several initial comments about the paper are worth making. First, it starts by establishing the time-series properties of the individual variables in the money demand function. The aim here is simply to show that the variables are integrated of the same order. The sampling distribution of the OLS estimator is not well behaved if the disturbance is non-stationary: The distribution of OLS estimator does not have finite moments, and, furthermore, OLS is inconsistent in general. If a unit root is present, it is essential to first difference the variables, thereby eliminating the unit root and achieving stationarity before attempting to estimate the money demand model. For this purpose, we use the augmented Dickey-Fuller (ADF) test as recommended by Engle and Granger (1987) in addition to the Durbin-Watson statistic suggested by Sargan and Bhargava (1983) to determine whether the time series are stationary in first differences or levels. Furthermore, we report the Z([[Phi].sub.3]) statistic suggested by Perron (1988). Second, efforts are made to examine the extent to which domestic money holdings are influenced by foreign interest rate considerations. Several researchers [for example, Arango and Nadiri (1981), and Arize et al. (1990)] have concluded that in estimating demand for money in small developing economies, the international opportunity costs of holding money balances should at least be considered along with the domestic counterpart. To examine this issue in the case of Taiwan, foreign interest rates are proxied by U. S. government bond yield (medium-term).(3) Third, modeling the dynamic adjustment of the model we use the error-correction procedure. The error correction methodology follows that in Engle and Granger (1987). Fourth, particular attention is given to testing for higher-order autocorrelation, functional form misspecification, heteroskedasticity, and normality of the residuals. Finally, the paper examines whether the Taiwan money-demand relationship has shifted during the period of estimation. …