The Demand for M1 in the United States: A Comment on Baba, Hendry, and Starr


WP/93/24-EA

The Demand for M1 in the United States:
A Comment on Baba, Hendry, and Starr by James M. Boughton

A 1992 paper by Yoshihisa Baba, David Hendry, and Ross Starr presents
a model of the demand for narrowly defined money (M1) in the United States
that shows a dramatic improvement in both fit and stability over earlier
models. This note estimates an alternative model that is based on the same
data set, uses a similar error-correction methodology, and has very similar
statistical properties to the original. Both models show remarkable
stability throughout the past three decades.

Two conclusions are that the improvements are due more to the use of
complex dynamics than to the introduction of variables representing
financial innovation (as alleged by Baba, Hendry, and Starr) and that some
of the economic properties are not robust with respect to minor changes in
specification. Notably, whereas in the original model, money demand has a
low elasticity to real income, which suggests substantial economies of scale
in money holdings, this alternative has a unitary elasticity, which suggests
that money and income should grow proportionately in the long run.