Liquidity Traps and the Stability of Money Demand:
Is Japan Really Trapped at the Zero Bound?

Ryuzo Miyao∗
Research Institute for Economics and Business Administration
Kobe University
Email: miyao@rieb.kobe-u.ac.jp

October 2002--- preliminary draft ---[Abstract]
Is the Japanese economy really trapped at the zero interest rate bound? The question
seems particularly important because recent theoretical discussions on liquidity traps
suggest that undesirable dynamics such as ``deflationary spiral’’ are likely to occur whenthe economy reaches the lower zero bound. This paper attempts to answer the above
question by analyzing the stability of an equilibrium money demand relationship inJapan. Specifically, it performs a formal analysis on the presence and stability of
cointegration in M1 demand in Japan and argues that the answer seems negative. With
the double-log specification, a cointegrating M1 relationship exists and is found to bestable (i.e. no break in the interest elasticity) even after 1995 when nominal rates werelowered to a decimal point level or virtually ``zero percent’’.

∗

I am grateful to seminar participants at Kobe University and Kosuke Aoki for helpfulcomments and discussions given to an earlier version of this draft. Any errors are of myown.
11. I n t r o d u c t i o n
Is the Japanese economy really in a ``liquidity trap’’? Liquidity traps may be broadly
defined as a situation in which conventional monetary policies are ineffective to raise
output or prices with near zero nominal interest rates. This broad definition seems to fit
Japan well. In fact, the call rate, a primary indicator of monetary policy in Japan, waslowered to 1 basis point (0.01 percent) in 1999 by the zero interest rate policy and further
down to 0.1 basis point by a sequence of aggressive monetary injections known as``quantitative easing’’ in 2001. Yet the economy exhibits no sign of strong recovery andprices are still gradually declining. All these observations seem consistent with the broad
definition of liquidity traps. 1
Perhaps more controversial is whether the Japanese economy has already reached thelower zero bound on nominal interest rates. Krugman (1999) refers to liquidity traps as asituation where money and bonds become perfect substitutes or indistinguishable whennominal rates vanish. If this is the case, money demand will be indeterminate. A further
increase in money supply will be simply hoarded by the public or banks by an arbitraryamount in the form of extra cash or excess reserves. This implies that an equilibrium or``long-run’’ money demand relation will cease to exist as residuals of that relationshipbecome no longer stationary. Alternatively, money demand becomes perfectly elastic at
the zero interest rates, so that one should observe a break in the interest elasticity. In
either case, reaching the zero floor may cause a fundamental shift in an equilibriummoney demand relation.
Recent theoretical contributions on liquidity traps also suggest that the economy at thezero interest rate bound has important implications in terms of economic dynamics. For
instance, Buiter and Panigirtozoglou (1999) develop a dynamic framework wheremonetary policy is assumed to follow an active interest rate feedback rule known as``Taylor (1993) rule.’’ Their phase diagram indicates that both a stable equilibrium innormal times and a lower, ``liquidity trap’’ equilibrium emerge. The latter one may
appear when deflationary pressures increase and the nominal rate actually reaches thezero floor. Reifschneider and Williams (2000) also employ a simple stylized model with a

See e.g. Miyao (2000, 2002) for recent evidence on the effectiveness of monetary policy
in Japan12Taylor rule and demonstrate that the economy exhibits a ``deflationary spiral,’’ where adecrease in inflation raises the level of real interest rates at the zero nominal rate, lowers
aggregate demand and inflation, and therefore raises the real interest rate even further.
Such instable dynamics tend to emerge when the economy stays at the zero interest ratebound and experiences further deflationary pressures. 2
Because these undesirable dynamics such as deflationary spiral are likely to occur
after the economy reaches the zero interest rates, it is all the more important to examine
empirically whether Japan is really trapped at the zero bound. To this end, we return tothe implications of zero interest rates on an equilibrium money demand relation
discussed above and examine the stability of money demand in Japan in some detail.
More specifically, we study the presence and stability of a cointegrating M1 demand
relation in Japan using quarterly observations for the period of 1975-2001. Some
previous studies addressed the issue of a liquidity trap in Japan and investigated it
empirically in one way or another.

But the existing evidence appears mixed. For

example, Hondroyiannis, Swany, and Tavlas (2000) showed that the absolute value of theestimated interest elasticity declines at a lower level of interest rates, which is contrary
to the presence of a liquidity trap. Nakashima and Saito (2002), on the other hand, useda semi-log specification and found that the interest semi-elasticity becomes larger inrecent years of low interest rate policy in Japan. Fujiki,Hsiao and Shen (2002) performeda dynamic panel analysis using Japanese prefecture data for 1992-97 and argued that
there is no evidence of a liquidity trap from perspectives of out-of-sample prediction.
Finally, Fujiki (2002) reexamined the aggregate stability using his cross-sectional
estimate of the income elasticity and documented a similar increase in the interest
elasticity as Nakashima and Saito (2002).3 With these mixed results, the question stillneeds to be resolved. In particular we address the issue concerning the interest elasticity

One may obtain different dynamics when the role of fiscal policy and/or the wealtheffect of deflation are taken into account. See also Benhabib, Shmitt-Grohe and Uribe(2001, 2002) who demonstrate a different type of instability. In their framework, a lower
liquidity-trap equilibrium emerges anywhere before the economy reaches the zero bound.
Note further that the lower equilibrium is also shown as stable (i.e. no deflationary
spiral).
3 Other related studies include Cargill, Hutchison and Ito (2000). They discussed rather
informally whether the recent ineffectiveness of Japan’s monetary policy can be
attributed to a liquidity trap as claimed by Krugman (1999).
2

3

versus semi-elasticity (i.e., the use of interest rates in log versus in levels) with some careas the difference necessarily matters near zero interest rates.
Summarizing our main results here, we find that (i) the presence of cointegration in
M1 is reasonably well supported by the data and (ii) with the double-log specification, therelationship is in fact found to be stable and no break in the interest elasticity is detected.
Thus the evidence seems to suggest that Japan is not yet trapped at the zero bound evenafter 1995 when nominal rates were lowered to a decimal point level and more or less``zero percent’’.

2. T h e o r e t i c a l B a c k g r o u n dThis section briefly reviews recent development on theories of liquidity traps. While
there seems little disagreement in terms of the broad definition of liquidity traps thatmonetary policies are impotent due to near or virtually zero interest rates, economic
theoriesonliquidity

traps

have

severalrelatedbut

nonethelessdifferent

characterizations.
Firstly, in a standard textbook-type presentation, liquidity traps are referred to as ahorizontal LM curve when money demand is perfectly elastic with respect to interest
rates. Thus there must be a break and a fairly large increase in the interest elasticity atsome low level of interest rates. Note that in this characterization, the lower bound on
nominal interest rates may not be necessarily zero and can be some positive value. From
optimality conditions under a standard money-in-utility framework, this implies thatmarginal utility of holding additional real balances is bounded at some positive level, i.e.
the desire of holding money is insatiable even when money holding becomes infinitely
large. Ono (2001) demonstrates that such insatiable liquidity preference generates theliquidity trap and neutralizes the Pigou effect, which in turn makes economic stagnation
persistent.
Secondly, Krugman (1999) defines liquidity traps as a situation where money andbonds become indistinguishable when nominal rates reach the lower zero bound. As wediscussed in the introductory section above, this implies that money demand becomesindeterminate and an equilibrium or long-run money demand relation will cease to exist.
Woodford (1999) also refers to liquidity traps as equilibria in which nominal rates are at
the lower zero bound and real money balances are at or beyond a finite satiation level4(i.e., the marginal utility of money is zero).
Thirdly, Buiter and Panigirtozoglou (1999) and Reifschneider and Williams (2000)
characterize liquidity traps in a dynamic framework in which monetary policy is
assumed to follow an active interest rate feedback rule known as ``Taylor (1993) rule.’’Buiter and Panigirtozoglou (1999) set up two differential equations (i.e. consumption
growth and Phillips-curve type inflation growth equatoins). Their phase diagram
indicates that there exists a saddle-path stable equilibrium in normal times when thezero bound constraint is not binding. But when the economy hits the zero bound due toan increase in deflationary pressures and the constraint is binding, a lower, ``liquidity
trap’’ equilibrium emerge. Reifschneider and Williams (2000) also employ a simple
stylized model with aggregate demand growth, inflation growth and again a Taylor rulewith the zero lower bound. They demonstrate that the economy exhibits both a stableequilibrium in normal times and ``deflationary spiral’’ after the zero bound constraint isbinding. The latter situation occurs because a decrease in inflation raises the level ofreal interest rates at the zero nominal rate, lowers aggregate demand and inflation, andtherefore raises the real interest rate even further. Note that in these two studies, theliquidity trap regime and the deflationary spiral region are attributed to nominal rates at
the zero lower bound.
Finally, Benhabib, Schmitt-Grohe and Uribe (2001, 2002) demonstrate a different typeof liquidity traps. They use an optimizing money-in-utility framework together with anactive Taylor rule and show that a stable, liquidity-trap equilibrium may emerge. Whatis different here is that liquidity traps may occur before the economy reaches the zerointerest rate bound, i.e, before the marginal utility of money becomes zero. This clearly
differs from the second and third characterizations above. This is also different from thefirst type because here no assumption of insatiable liquidity preference (whichcorresponds to a positive lower bound of the marginal utility of money) is imposed. Thus,
unlike the above three cases, Benhabib and others’ liquidity traps may emerge evenwhen an equilibrium money demand relation is well defined.
The brief review of these theories of liquidity traps motivates our formal econometricanalysis of Japanese money demand in the subsequent section. If we fail to support thepresence of cointegration in money demand especially in recent years of near zeronominal rates, this suggests that Japan may experience Krugman’s liquidity traps where

5the zero interest rate bound is reached and undesirable dynamics such as deflationary
spiral may be likely to occur.

Alternatively, when we support the presence of

cointegration but detect a break in the interest elasticity and moreover the elasticity
becomes fairly large, then we cannot rule out the possibility of the first, conventional typeof liquidity traps. The stagnation story regarding insatiable liquidity preference may also
apply. A formal cointegraiton analysis of long-run money demand helps us understandthe presence and nature of a possible liquidity trap in Japan.4

3. I n v e s t i g a t i n g t h e S t a b i l i t y o f M o n e y D e m a n d i n J a p a n
We analyze the following two forms of a conventional money demand relationship withassuming the unit income elasticity:

M − P − Y − βr LRCALL = e~
M − P − Y − βr RCALL = e

(1)
(2)

where M, P, and Y denote nominal money supply (here M1), the price deflator (here theGDP deflator) , and real output (real GDP), all in logarithm, LRCALL and RCALL denote~the overnight call rate in log and in levels, respectively, βr and βr are the interest
elasticity and semi-elasticity, respectively, and e is the money demand residual.5 Thus
equations (1) and (2) correspond to the ``double-log’’ and ``semi-log’’ forms of an
equilibrium money demand relation. We use quarterly observations for the period of
1975:1-2001:4.6

Not to mention, even when the evidence is in support of both the presence and stabilityof cointegration, we cannot rule out the possibility of Benhabib and others’ liquidity
traps.
5 We assume the unit income elasticity mainly because the dimension of the estimation
system is reduced and thereby more reliable empirical results can be obtained in the
cointegration analysis below. Note that one can derive the unit income elasticity
specification from a standard money-in-utility framework with log or CRRA type utility:
see e.g. Walsh (1998). However, to check robustness, we later impose alternative valuesof the income elasticity taken from cross-sectional estimates by Fujiki (2002) and Fujiki,
Hisao and Shen (2002).
6 M1 is seasonally adjusted, monthly average series taken from the Nikkei Database(MT code 32917) and monthly observations are averaged within each quarter to obtain
quarterly series. Real GDP and GDP deflator are seasonally adjusted and retrieved from
93SNA. Because 93SNA data are available since 1980, they are linked withcorresponding 68SNA data at 1980:1. These SNA statistics can be taken from the
Cabinet Office of Japan’s web site at www.esri.cao.go.jp/en/sna/menu.html. The call rateseries is constructed first by linking the uncollateralized overnight rate (monthly
46

As a preliminary to apply the concept of cointegration, we perform unit root tests foreach of the variables: M − P − Y (which is denoted as M1VEL hereafter) and the twocall rate series LRCALL and RCALL. We run the augmented Dickey Fuller (1979) testsof a unit root against no unit root (ADF), and a modified Dickey-Fuller test based on GLS
detrending series (DF-GLS), a powerful univariate test proposed by Elliot, Rothenberg
and Stock (1996). A constant term is included in both tests. We further perform thesequential minimal Dickey-Fuller test proposed by Banerjee, Lumsdaine and Stock(1992) (denoted as BLS) that allows for a break in a deterministic trend in an unknown
timing. In all these tests, the optimal lag length is chosen based on SBIC (up to six lags).
As shown in Panel A of Table 1, no tests reject the null of a unit root against thealternative of stationarity even with the allowance of a possible break in a linear trend.
Taking the first difference, both ADF and DF-GLS detect strong rejections for all thecases (Panel B). These results imply that each of the underlying variables can betreated as a single unit root process or integrated of order one (I(1)).
We now proceed to the cointegration analysis for equations (1) and (2). Here twoconventional cointegration tests are performed: the augmented Dickey-Fuller test of no
cointegration against cointegration (denoted ADF again) and Johansen's (1988) andJohansen and Juselius's (1990) maximal eigenvalue test of no cointegration against one
cointegrating vector (JOH). Moreover, to allow for a possible break in cointegration, we
employ a test procedure proposed by Gregory and Hansen (1996) and implement theaugmented Dickey-Fuller test of no cointegration against cointegration with a structuralshift in cointegration (i.e. a break in the cointegrating vector --- both intercept and slope
coefficients) in an unknown timing (denoted as GH). The optimal lag length is chosen
based on SBIC and is shown in parentheses except for JOH test with RCALL, where fivelags are arbitrarily used. 7 Critical values for each of the tests are tabulated byaverage) after July 1985 and the collateralized rate (monthly average) until June 1985
and then taking average of monthly observations in each quarter. In linking the twoseries, the mean difference between the two is added to the collateralized rate. These callrate data are taken from the statistics section of the Bank of Japan homepage atwww.boj.or.jp. Note also that the starting date here is chosen to avoid possible structural
breaks in the early 1970s including the first oil crisis and the exchange rate regime shift.
7 Using SBIC, one lag is selected with RCALL for JOH, which appears too short. We
perform a modified likelihood ratio test proposed by Sims (1980) and test (i) one lag
versus five lags and (ii) five lags versus eight lags. Then the null of one lag is rejected in7

MacKinnon (1991) for ADF, Osterwald-Lenum (1992) for JOH, and Gregory and Hansen(1996) for GH. As for JOH, following the procedure by Cheung and Lai (1993),
Osterwald-Lenum’s critical values are corrected to account for possible size distortions(over-rejections) in finite samples.
Table 2 reports the cointegration test results. Using conventional ADF tests, we cannot
detect cointegration. On the other hand, JOH tests consistently support cointegration
with finite-sample critical values. When we allow for the possibility of a structural shift
in cointegrating vector, GH test detects cointegration with the logged call rate (LRCALL)
but not with the call rate in levels. Because augmented Dickey-Fuller tests are known tohave a low power in general, we interpret that the failure of ADF (or partially GH)
detecting cointegration can be attributed to a low power of these tests. On the other hand,since the Johansen procedure here already takes into account the over-rejection problem
in finite samples, these consistent rejections by Johansen tests of Table 2 are reasonably
reliable. Thus the evidence seems generally in support of the presence of a cointegrating
M1 demand relation in Japan. Because money demand residuals are characterized asstationary, we view that the Japanese economy has not yet experienced the zero interest
rate bound.
Given that cointegration in M1 exists, we then investigate parameter stability, i.e.,
constancy in the cointegrating vector. We perform Hansen’s (1992) two stability tests:
SupF and MeanF.

SupF tests the null of constancy against the alternative of aparameter shift in an unknown timing. MeanF tests the null of stability against thealternative of instability where the parameter follows a random walk process. The
Bartlet kernel estimator (unprewhitened) is used with automatic bandwidth selection
procedure proposed by Andrews (1991). We further employ Hansen and Johansen’s(1993) stability test (denoted as HJ). In that procedure we use the benchmark parameterthat is estimated with the subsample upto the second quarter of 1995. Note that the callrate was lowered to a decimal point level (i.e. below one percent) in July 1995. We test thenull hypothesis that the benchmark estimate is equal to the parameter estimated withthe full sample. HJ test statistics follow a chisquare distribution with degree of freedom

the former test and the null of five lags is not rejected in the latter, which seems to justify
the present five lag specification.
8

2.
Table 3 summarizes the stability tests results. Using LRCALL, we are unable to reject
the null of parameter constancy from all the three tests, providing support to thestability in M1 demand relation (i.e. no break in the interest elasticity). On the other
hand, when RCALL is used, we find consistent rejections from each of the three stability
tests. These results suggest that while the interest elasticity remains stable during thesample period, the interest semi-elasticity shifted during the sample period, particularly
in 1995. The possible shift in the semi-elasticity is consistent with the finding byNakashima and Saito (2002).
Finally we estimate the cointegrating vector by dynamic OLS procedure of Saikkonen(1991) and Stock and Watson (1993). Five leads and lags are used in these estimations
together with the Newey-West standard error with five lags truncation. We estimate thecointegrating vector with and without allowing a possible break in 1995:2/1995:3. Herethe sample period begins in 1985 (i.e. 1985:1-2001:4) in order to make a comparison withearlier studies such as Nakashima and Saito (2002) and Fujiki (2002).8
Table 4 presents the estimation results. The estimated interest elasticity βr with nobreak is -0.133 for LRCALL. When a possible break at 1995:2 is allowed in the double-log
specification, estimated shifts in a constant and the elasticity coefficient turn out
insignificant, as shown in Panel B (first row). This is in contrast with Fujiki’s (2002)
finding in which he reports a substantial increase in the interest elasticity in 1995. On
the other hand, when RCALL is used, we find a significant break both in the constant~term and the semi-elasticity βr . The point estimates indicate that the interest
semi-elasticity becomes larger by 0.530 in absolute values (i.e. from -0.025 to -0.555).
The estimated shift looks largely consistent with the evidence of Nakashima and Saito(2002).9

4. D i s c u s s i o n s
The main findings in the previous section can be summarized as follows. First,
8 We also obtain similar estimation results using the full sample period.

Nonethelss theestimates appear more precise with smaller standard errors when the 1985 sample isused and therefore we choose to report the 1985 results in the text.
9 Their point estimates range from-0.035 to -0.038 before 1995 and from -0.571 to -0.746
after 1995.
9

cointegration in M1 demand is largely supported by the data. Second, with the double-log
specification, the interest elasticity is found to be stable, but using the semi-log form,
the interest semi-elasticity increased in 1995.
Then how can we interpret these two seemingly conflicting results in terms ofstability? The answer may be straightforward if we look at scatter plots of actual data.
Figure 1 displays two scatter plots: (A) LRCALL versus M1VEL and (B) RCALL versus
M1VEL for the period of 1985:1-2001:4. While the relationship looks fairly stable ingraph A, one can observe an apparent break near zero percent in graph B. These areexactly what the formal analysis finds above. But it is also evident that graph B canapproximate the very log function.

If this is the case, then the two graphs would

suggest the same result of stability in terms of the interest elasticity.
This interpretation can be supported using the point estimates of the two~elasticities βr and βr as well. Recall that in Table 4 the estimated elasticity

βr~equals -0.133 and the semi-elasticity βr rises from -0.025 to -0.555 in 1995. By~

definition, βr /r = βr (where r is nominal interest rates) and using the average of the callrate before and after 1995 (4.573 percent for 1975:1-1995:2 and 0.287 percent for
1995:3-2001:4), we can compute the implied semi-elasticity for each period. These are-0.028 before 1995 and -0.463 after 1995 and therefore reasonably close to the actual
point estimates of the semi-elasticity for each period. Again, we are able to demonstratethat the observed increase in the semi-elasticity is consistent with the stable elasticity.
From these considerations, I would like to interpret that the two conflicting results canbe reconciled with each other and that the findings here consistently suggest that theinterest elasticity in Japan remains stable even after 1995. Accordingly the previous
evidence of instability by Nakashima and Saito (2002) may be reconciled with thisinterpretation.
Finally let me discuss the evidence of instability documented by Fujiki(2002). Fujiki
imposed his cross-sectional estimate of the income elasticity (0.874) as opposed to theunit income elasticity and showed that there was a substantial increase in the interest
elasticity rather than semi-elasticity in 1995. In Figure 1 (graph A), one may observe theslope somewhat steeper for several years in the middle of the sample (those observations
are for 1995-1999). Fujiki’s subsample estimation by OLS may pick up this shift. Notealso that his sample ends in August 2000, while our sample here ends in 2001:4. The last10

three observations after 2001:2 correspond to the aggressive quantitative easing by the
Bank of Japan and consequently the call rate was further lowered below 1 basis pointlevel. Adding these observations would seem helpful to maintain the stable relationshipin graph A.
To check robustness of our findings, we impose Fujiki’s estimate of the income
elasticity rather than the unit income elasticity and perform the same exercises as above.
But our main fin dings are unaffected. We obtain similar cointegration and stability test
results. The dynamic OLS estimate of the interest elasticity for the full sample is -0.140,
while the semi-elasticity estimates before and after 1995 are -0.030 and -0.560,
respectively, so that the above interpretation may be maintained.

5. Conclusion
We investigated whether in fact the Japanese economy is trapped at the zero interest
rate bound. While several different characterizations on liquidity traps are possible, thequestion seems particularly important because undesirable dynamics such as``deflationary spiral’’ are likely to occur when the economy actually reaches the zerobound. And at zero interest rates, money demand becomes indeterminate and therefore
is not well defined, or it becomes perfectly elastic with respect to the interest rates. We
thus examined the presence and stability of an equilibrium money demand relation(cointegrating M1 relation) in Japan for 1975-2001.
Our evidence suggests that the answer would be negative. With the double-log
specification, a cointegrating M1 relationship exists and is found to be stable (i.e. nobreak in the interest elasticity) even after 1995. The observed constancy in the interest
elasticity can be reconciled with the previous evidence of instability in the interest
semi-elasticity such as Nakashima and Saito (2002). We also checked robustness by
imposing Fujiki’s(2002) cross-sectional estimate of the income elasticity rather than theunit income elasticity.
It might be reassuring that the Japanese economy has not yet been trapped at the zerobound. An equilibrium money demand relation is stable and still well defined. Therefore
the Japanese economic conditions even in such difficult times can be viewed as fully
consistent with standard economic thinking such as optimizing behavior of householdswith money-in-utility. Moreover, the undesirable deflationary trap case may not be an

11urgent concern.
Nevertheless we should note somewhat paradoxically that monetary policy remains
ineffective to affect output or prices even with the stable money demand relation. As weobserve in Figure 1 (graph A), the call rate in log now takes a negative value and has
been lowered substantially by recent quantitative easing. With the stable interest
elasticity, this also raised money demand of the public (i.e. Marshall’s k) substantially,
and therefore P and Y remain unaffected even when a huge amount of M was suppliedThus Japan’s well-defined money demand relation has been, and perhaps will be forsometime to come, consistent with strong money hoarding by the public and ``a liquidity
trap’’ in general terms.

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15

Table 1. Unit Root Test Results―――――――――――――――――――――――――――――――――――――――――
Variable

ADF

DF-GLS

BLS―――――――――――――――――――――――――――――――――――――――――
A. In levels
M1VEL

3.05(1)2.13(1)-3.34(1)

LRCALL

3.19(5)3.99(5)-3.51(5)RCALL-2.09(1)-0.08(3)-4.04(1)

B. In first differences
ΔM1VEL

-5.98(0)**-5.61(0)**---ΔLRCALL-7.10(4)**-2.65(5)*---ΔRCALL

-5.72(2)**-5.42(2)**---―――――――――――――――――――――――――――――――――――――――――
Notes: This table reports statistics testing for a unit root for a reciprocal of M1 velocity(M1EL), the logged call rate (LRCALL), and the call rate in levels (RCALL). ADF is theaugmented Dickey-Fuller (1979) test of a unit root against no unit root, and DF-GLS is a
Dickey-Fuller test based on GLS-detrended series, proposed by Elliott, Rothenberg andStock (1996). A constant term is included in both tests. BLS is the sequential minimal
Dickey-Fuller test proposed by Banerjee, Lumsdaine and Stock (1992) that allows for abreak in a deterministic trend in an unknown timing. In all these tests, the optimal lag
length is chosen based on SBIC and is shown in parentheses. The sample period is
1975:1-2001:4.

Critical values, tabulated by Fuller (1976), Elliott, Rothenberg andStock (1996), and Banerjee, Lumsdaine and Stock (1992) are:10%(†)

5%(*) 1%(**)

ADF

-2.58

-2.89

-3.51

DF-GLS

-1.61

-1.95

-2.60

BLS

-4.20

-4.48

---

16

Table 2. Cointegration Test Results―――――――――――――――――――――――――――――――――――――――――
Variable

ADF

JOH

GH

―――――――――――――――――――――――――――――――――――――――――
LRCALL-2.20(5)19.15(5)*-5.06(1)*RCALL

0.08(3)22.12(5)*-3.13(1)―――――――――――――――――――――――――――――――――――――――――
Notes: This table reports statistics testing for cointegration between M1 velocity(M!VEL) and the logged call rate (LRCALL) or the call rate (RCALL). ADF is theaugmented Dickey-Fuller (1979) test of no cointegration against cointegration. JOH is
Johansen s maximal eigenvalue test of no cointegration against one cointegrating vector.
GH is the augmented Dickey-Fuller test of the null of no cointegration against thealternative of cointegration with a possible structural break, proposed by Gregory andHansen (1996). The optimal lag length is chosen based on SBIC and is shown inparentheses. The exception is for the case of JOH test with RCALL, in which five lags arearbitrarily used (see footnote 7 in the text). Critical values are tabulated by MacKinnon(1991) for ADF, Osterwald-Lenum (1992) for JOH, and Gregory and Hansen (1996) for
GH. As for JOH, following the procedure by Cheung and Lai (1993), Osterwald-Lenum s
critical values are corrected to account for possible size distortions in finite samples.
10%(†) 5%(*) 1%(**)
ADF

-3.10

-3.41

-3.51

JOH

15.09

17.23

22.21

GH

-4.68

-4.95

-5.47

17

Table 3. Stability Tests Results―――――――――――――――――――――――――――――――――――――――――
Variable

SupF

MeanF

HJ

―――――――――――――――――――――――――――――――――――――――――
LRCALL

5.47

2.90

1.29

RCALL

207.79**62.50**

7.57*―――――――――――――――――――――――――――――――――――――――――
Notes: This table reports statistics testing for stability of a cointegrating M1 demand
relation in Japan. SupF is Hansen s (1992) procedure that tests the null of constancy
against the alternative of a parameter shift in an unknown timing. MeanF is another
Hansens (1992) procedure that tests the null of stability against the alternative of

instability where the parameter follows a random walk process. For both tests, theunprewhitened Bartlet kernel estimator is used with the corresponding automatic
bandwidth selection proposed by Andrews (1991). HJ is Hansen and Johansens (1993)

procedure testing that the benchmark parameter estimated with the subsample of1975:1-1995:2 is equal to the parameter estimated with the full sample. Five lags are
assumed here. HJ statistics follows a chisquare distribution with degree of freedom 2.
Critical values for SupF and MeanF tests are tabulated by Hansen (1992):
10%(†)

5%(*)

1%(**)

SupF

10.6

12.4

16.2

MeanF

3.73

4.57

6.78

18

Table 4. Estimates of the Cointegrating Vector―――――――――――――――――――――――――――――――――――――――――
Variable

Constant

βr , β~r

Shift in constant~

Shift in βr , βr―――――――――――――――――――――――――――――――――――――――――
A. With no break
LRCALL

RCALL

1.164

-0.133(0.011)(0.006)1.323-0.071(0.055)(0.011)
B. With a Break at 1995:2/1995:3

LRCALL

RCALL

1.131

-0.1120.010(0.032)(0.017)(0.028)-0.031(0.017)1.087-0.0250.400-0.530(0.019)(0.004)(0.026)(0.050)―――――――――――――――――――――――――――――――――――――――――
Notes: This table reports estimates of cointegrating vector (the interest elasticity andsemi-elasticity) using the dynamic OLS method proposed by Saikkonen (1993) and Stockand Watson (1993). Five leads and lags are used in these estimations. Newey-Weststandard error is computed with five lag truncation and shown in parentheses. In PanelA, no break in the cointegrating vector is allowed, while in Panel B, a possible break at
1995:2/1995:3 is permitted．The sample period is 1985:1-2001:4 .

19

Figure 1. Scatter Plot(A) LRCALL and M1VEL- 1985:1-2001:4 1.8

M1VEL

1.6
1.4
1.2
1
0.8
-7

-6

-5

-4

-3 -2 -1
LRCALL

0

1

2

3

7

8

9

(B) RCALL and M1VEL- 1985:1-2001:4 1.8

M1VEL

1.6
1.4
1.2
1
0.8
0

1

2

3

4
5
RCALL

20

6