Money Demand Function through Cointegration Property of M₂＋CD Decomposed into M₁ and Quasi Currency＋CD

Abstract

We analyze a money demand function in long equilibrium relation that is defined by a cointegration property among (money, gdp, interest rate). A wide sense of money ”M₂＋CD” consists of narrow money ”M₁” and wide one ”quasi currency＋CD”(denoted by q-money). Regarding money as an asset, a rigorous correspondence of money to interest rate requires that M₁ and q-money should be coupled with short-term interest rate and spread interest rate (long-term interest rate minus short-term one) respectively. Hence, The cointegration between M₂＋CD and gdp should be described by two kinds of interest rates stated above.Due to a deflationary economy in Japan, cointegration property is said to break down, because for future anxiety people save money and the balance between gdp and total amount of money is disturbed. Such saved money is called ”precautionary demand”. Assuming that precautionary demand is proportional to the magnitude of recession, we define adjusted moneys M_1adj ＝ M₁ － k₁ * |recession| and q-money_adj ＝ q-money － k₂ * |recession| respectively and can show that the cointegration property holds among (M₂＋CD, gdp, interest rates) by using M_1adj and q-money_adj with parameters k₁ and k₂ estimated.