Silviase/jgov_v1.4_full_ann huggingface dataset:
substitution between money and real assets rather more significant than that of between money and financial assets. $ ^{5} $ Furthermore, substitution between domestic money and foreign currency or foreign bonds may be particularly relevant for some countries. $ ^{6} $ Another important factor of the determination of money demand for the developing countries could be the existence of an unorganized financial market. Although there might be some linkage between organized market and unorganized market, the returns of the unorganized market are claimed as being much higher and more volatile than those of the organized market. Though information of financial yields in unorganized financial sector is hard to obtain, the movements of those returns could significantly affect the private money demand in a developing country. $ ^{7} $ Finally the empirical analyses of the money demand function for the developing countries may require careful treatment of the long-run institutional changes. These factors may include factors such as the ratio of the labor force outside the agriculture, the ratio of population to bank offices, the ratio of currency to the total money stock and so on. $ ^{8} $ With these reservations in mind, we restricted ourselves to using money market rate, if available, as relevant interest rates in the estimation of the money demand function.

In any event, for Japan, we used interbank-market rates as the typical interest rate. We estimated separate money demand function for the fixed exchange rate period and the flexible exchange rate period.
For Korea, our problem was that as the money market rate was available only from 1977, so in turn we adopted the yields of government bond as the representative interest rate. $ ^{9} $ The division of the sample period follows that of the previous chapter.

For Indonesia and the Philippines, the money market rates were available for the entire sample period and the sample periods remain unchanged.

### 3.3 Estimated Money Demand Functions

In this section, we will review the results of money demand functions. Estimated results are summarized in Table 3.1. Let us examine the results for individual countries, respectively.

## (i) Japan $ ^{10} $

For the first period, the interest rate as well as the real GNP were significant only at the 10% level. However, both real GNP and interest rate became significant at the 1% level for the flexible exchange rate regime. In terms of the long-run income elasticities, it is surprising to see that long-run income elasticity for the second period apparently exceeds one. This result might be explained by the whole range of new financial instruments with rather market-determined interest rates.

The estimated result for the fixed exchange rate regime is not satisfactory with usual standards. However, as done in Furukawa (1985), if we change the sample period ending in 1974:IV, real GNP and interest rate variables are found to be significant at the 1% level. $ ^{11} $

It is clear from this result that there existed a substantial structural break of the
money demand function across the sample periods. Moreover, the coefficients of the interest rate for the flexible exchange rate period were much smaller from those of the first period. Especially the long-run interest rate elasticity became half of that for the first period. Since financial deregulation induces availability of money substitutes paying competitive rates of return, it can be argued that the financial liberalization and the financial internationalization were consistent with this finding. $ ^{12} $

## (ii) Korea

For the first period, though the real GNP was found to be statistically significant at the 1% level, the interest rate was significant only at the 10% level. The qualitative conclusions did hold for the second period as well: while real GNP turned out to be significant at the 5% level, interest rate was only significant at the 10% level. In terms of the long-run income elasticities, both estimates seem to be close enough to one. $ ^{13} $

As in the case of Japan, it seems clear that there existed serious structural change of the money demand function for the Korean economy as well. The coefficients of the interest rate of the money demand function were considerably reduced in the second period. Especially in terms of the long-run interest rate elasticities, estimate for the second period is surprisingly lower than that of the first period. While the extent of the financial liberalization for the Korean financial markets were often regarded to be less radical, the institutional changes of the financial markets may explain these results.

## (iii) Indonesia

For the first period, though interest rate is only significant at the 10% level, real GNP turned out to be significant at the 1% level. Nevertheless, for the second period, both variables remain significant only at the 20% level. In terms of the long-run income elasticities, estimates for the two periods are extremely high (2.52 and 2.83, respectively). Since these long-run income elasticities were calculated using the coefficient of adjustment, implausibly long adjustment lags implied here could lead this finding. However, these figures are not much different from the figures for Japan and
Korea and comparable to the figures for the post-war U.S. results. $ ^{14} $ Aghevli etc. (1978) note that long-run income elasticities for the developing countries sometimes become greater than one. $ ^{15} $ As they argue, monetarization, $ ^{16} $ limited scope of economization of cash balance, and the scarcity of other financial instruments may explain these results. $ ^{17} $ On the other hand, we may note that in the annual analyses of the money demand function such as Meltzer (1963, U.S. 1900-1958), Lucas (1987, U.S. 1900-1985), Laidler (1966, U.K. 1919-1960), Artis and Lewis (1984, U.K. 1920-1981), most of long run income elasticities were close to unity. $ ^{18} $

Somewhat surprisingly, the coefficients of the interest rate for two sample period did not differ substantially from that of the first period. However, in terms of the long-run elasticities, the figure for the second period is smaller than that of the first period. This makes rather a sharp contrast with the cases of Japan and Korea. Finally
### TABLE 3.1: MONEY DEMAND FUNCTION

COUNTRY	PERIOD	CONSTANT	GNP	INT	M/P(-1)	LONG-RUN INCOME	LONG-RUN INTEREST RATE	Coefficiant of ADJUSTMENT	R²	DW
JAPAN	1962:II - 1973:I
.01	.12	-.031	.882	1.02	.263	.118	.998	2.484
(.082)	(1.639)	(-1.78)	(13.006)
JAPAN	1973:III - 1990:I
-.895	.202	-.017	.87	1.55	.131	.13	.998	1.551
(-3.41)	(3.438)	(-3.784)	(21.812)
KOREA	1973:IV - 1979:IV
.068	.339	-.195	.724	1.23	.707	.276	.963	2.283
(.181)	(2.818)	(-1.778)	(5.959)
KOREA	1980:II - 1990:I
-.076	.257	-.031	.769	1.11	.134	.231	.996	1.286
(-.380)	(2.291)	(-1.674)	(7.545)
INDONESIA	1977:II - 1983:IV
-1.865	.405	-.048	.839	2.52	.298	.161	.986	1.723
(-3.18)	(3.059)	(-2.022)	(12.273)
INDONESIA	1983:II - 1990:I
-5.012	.797	-.057	.718	2.83	.202	.282	.982	2.248
(-2.138)	(2.253)	(-2.188)	(5.745)
PHILIPPINE	1981:II - 1990:I
.328	.296	-.007	.849	1.96	*	.151	.851	2.639
(.382)	(1.729)	(-.239)	(10.193)

Notes: GNP=real GNP, INT=interest rate, M/P(-1)=lagged value of real money balance.

$ \overline{R}^{2} $ =adjusted $ R^{2} $ , DW=Durbin-Watson statistics.

Numbers in the parentheses indicate t values.
we may note that the coefficient on the lagged dependent variable substantially varies, suggesting some change in the nature of adjustment process.

Since we had a data discontinuity problem for Indonesia, a serious reservation of this results is in order. However, as substantial measures for the financial liberalization were documented in Indonesia since 1983; this result poses an open question.

## (iv) The Philippines

Only the yields for the treasury bills were available for the market interest rate variable. Though the real income was significant at the 10% level, the yields of TB were not significant at all in this result. The long-run income elasticity is 1.98, far greater than one. Thus Philippine financial economy might remain at the stage of the developing economies. Further investigation of the money demand function will be discussed in Section 3.5.

A concluding observation for foregoing empirical results seems to be as follows: except in the Philippine case, the interest sensitivities of money demand for the respective countries were not negligible, though not completely satisfactory, hence the traditional monetary transmission mechanism for the monetary policy should deserve at least some credit. Moreover, though instability of the money demand function will be examined in the following sections, the problem seems to be the most apparent for Japan and Korea at this stage.

### 3.4 Stability of the Money Demand Function

In this section, we will scrutinize in detail the stabilities of the money demand function within a given sample period. Since the Philippine results for the money demand function are not convincing yet, we will concentrate on other the countries.

As reviewed in Chapter 1, these countries examined here undertook serious financial liberalization efforts in the 1980's. Though financial liberalization, in general, improves the efficiency of the financial sector, drastic change of the institutional setting and the emergence of new financial instruments may create serious problems for the stability of money demand function. For example, liberalization of interest rates, inducing a reassessment of portfolios, may result in a discrete change in the interest elasticity of money demand. Furthermore, the returns on the newly created financial instruments could be significant determinants of the money demand. However, such measures to improve the function of financial institutions may attract savings from the unofficial market, as happened in Korea. If that is the case, it is possible that total
money demand will increase.

Since Goldfeld's (1976) well-known case of missing money, the stability of money demand function became a cornerstone in applied macroeconomics. Vast empirical studies examined this issue for various countries and time periods. Instability issue of the money demand function were frequently related to regulatory changes, as mentioned above. Hence, the stability of the money demand function deserves close examination under these circumstances. $ ^{19} $ For structural stability of the money demand function, see also Judd and Scadding (1982) for different perspectives.

We used historical facts, i.e. the exchange rate system, to divide entire sample years into two periods for Japan and Korea. Furthermore, the data discontinuity problem with same institutional factor forced us to divide sample years into two periods for Indonesia. Nonetheless, from the practical viewpoint, the stability of the money demand function even within a given sample period can not be easily dismissed. One way to pursue this issue is to use both historical facts and a statistical test such as the Chow test to detect a single break point within a sample period. Nevertheless, even within a given sample period, it is quite possible to have multiple break points. Using the usual Chow test under those circumstances might lead to misleading conclusions, in general. Hence, in the next subsection, the stability test with sequence of Chow test is reported to detect possible break points. In this context, it must be emphasized that the regulatory changes and financial innovations focused here were rather continuous; for example, in Indonesia, interest rates and credit ceilings were deregulated in 1983, money market instruments were introduced in 1984, the ceiling on swaps were removed in 1986, the bank entry were allowed in 1988 and so on. Given those series of events which might affect the behavior of the money demand function respectively, the importance of the use of sequential stability test statistics would be reasonably founded.

#### 3.4.1 Sequential Chow Test

Let us review the results of the test statistics for each country.

## (i) Japan

The graph of the calculated test statistics for the first period is presented in Figure 3.1. Money demand function became rather unstable in the period from 1969 to
FIG. 3.1: CHOW TEST JAPAN, 1963: I - 1972: I

FIG. 3.2: CHOW TEST JAPAN, 1974: II - 1989: I
FIG. 3.3: CHOW TEST KOREA, 1974: III - 1978: IV

FIG. 3.4: CHOW TEST KOREA, 1981: I - 1989: I
FIG. 3.5: CHOW TEST INDONESIA, 1978: I - 1982: IV

FIG. 3.6: CHOW TEST

INDONESIA, 1984: II - 1989: I
1971. The most apparent structural break can be observed during 1970. In fact, the null hypothesis of no structural break can be rejected at the 5% level for these terms. Hence the stability of the money demand function within first sub-period can be called into serious doubt. For the second period, the same graph was shown in Figure 3.2. The test statistics for the first few years reveals instability of the money demand function as well. Hence as a concluding observation for the Japanese case, we should note that the instability of the money demand function in the seventies is clearly revealed by these sequential Chow tests.

## (ii) Korea

The same charts for the first and second period are given in Figure 3.3. and 3.4. For the fixed exchange rate regime, though a statistically significant structural break was observed in 1974:III, it seems that money demand function was fairly stable for the rest of the period. For the second period, we observe a possible break point in 1982. However the null hypothesis of no structural break can not be rejected by these test statistics at the 5% level. The rest of the calculated statistics do not indicate any serious instability problem for the money demand function for Korea.

## (iii) Indonesia

The results of the sequential Chow tests are shown in the Figure 3.5. and 3.6. For the first sample period, a slight peak for the structural break can be noticed in 1982, the values for the rest of the period are rather small. For the second period, a slight peak can be perceived in 1986 as well, the calculated test statistics do not present any instability problem of the money demand functions. However, it should be noted that possible structural breaks coincided with balance of payments crises.

Thus, in terms of the sequential Chow test statistics, instability of the money demand function is the most serious in Japan. For Korea and Indonesia, perhaps this issue need not be taken too seriously $ ^{20} $ example, Pesaran, Smith, and Yeo (1985).

#### 3.4.2 CUSUM AND CUSUMSQ TEST

In addition to sequential Chow test, structural stability of the money demand function is examined by the cumulative sum (CUSUM) and CUSUM of squares
### FIGURE 3.7 CUSUM TEST : JAPAN, FIRST PERIOD Plot of Cumulative Sum of Recursive Residuals

The straight lines represent critical bounds at 5% significance level

FIGURE 3.8 CUSUMSQ TEST : JAPAN, FIRST PERIOD Plot of Cumulative Sum of Squares of Recursive Residuals

The straight lines represent critical bounds at 5% significance level
FIGURE 3.9 CUSUM TEST : JAPAN, SECOND PERIOD Plot of Cumulative Sum of Recursive Residuals

The straight lines represent critical bounds at 5% significance level

FIGURE 3.10 CUSUMSQ TEST : JAPAN, SECOND PERIOD Plot of Cumulative Sum of Squares of Recursive Residuals

The straight lines represent critical bounds at 5% significance level
(CUSUMSQ) tests, originated by Brown, Durbin and Evans (1975). The CUSUM test statistic is sum of the recursive residuals normalized by the standard error of the residuals and the CUSUMSQ statistic is the sum of squared recursive residuals normalized by the residual sum of the squared errors for the full sample period. In the figures discussed below, critical values at 5% significance level, given by Harvey (1981), are also shown. Although any departures from the bounds indicates misspecification of time variation in the parameters, CUSUM test is insightful for detecting systematic changes of coefficients, with CUSUMSQ test being useful for recognizing sudden events. $ ^{21} $

Let us review the calculated test statistics for each countries.

## (i) JAPAN

The CUSUM and CUSUMSQ statistics are shown in Figure 3.7 - Figure 3.10. For the first period, though CUSUM test statistics do not signify any structural problem, CUSUMSQ statistics exceed the lower 5% bound from 1969:III through 1971:II, indicating hazardous variations of the coefficients. For the second period, however, although CUSUMSQ test statistics do not reveal any serious instability of the money demand function, CUSUM test statistics exceed the upper 5% bound from 1987:III. This finding provides another evidence of the instability of the money demand function for the Japanese economy in this period.

## (ii) KOREA

Test statistics are plotted in the Figure 3.11 - Figure 3.14. For the first period, though Chow test suggests possible structural break in 1974, CUSUM test statistics around 1977 almost touch the upper 5% bound. However, both statistics do not indicate any serious structural changes otherwise. For the second period, as with sequential Chow test, none of the serious instability of the money demand function was detected by both test statistics.

## (iii) Indonesia

Relevant test statistics are shown in Figure 3.15 - Figure.18. None of the serious problem of the structural stability of the money demand function are suggested by these figures. Thus as a summary, the CUSUM and CUSUMSQ test statistics largely
FIGURE 3.11 CUSUM TEST : KOREA, FIRST PERIOD Plot of Cumulative Sum of Recursive Residuals

The straight lines represent critical bounds at 5% significance level

FIGURE 3.12 CUSUMSQ TEST : KOREA, FIRST PERIOD Plot of Cumulative Sum of Squares of Recursive Residuals

The straight lines represent critical bounds at 5% significance level
FIGURE 3.13 CUSUM TEST : KOREA, SECOND PERIOD Plot of Cumulative Sum of Recursive Residuals

The straight lines represent critical bounds at 5% significance level

FIGURE 3.14 CUSUMSQ TEST : KOREA, SECOND PERIOD Plot of Cumulative Sum of Squares of Recursive Residuals

The straight lines represent critical bounds at 5% significance level
FIGURE 3.15 CUSUM TEST : INDONESIA, FIRST PERIOD Plot of Cumulative Sum of Recursive Residuals

The straight lines represent critical bounds at 5% significance level

FIGURE 3.16 CUSUMSQ TEST : INDONESIA, FIRST PERIOD Plot of Cumulative Sum of Squares of Recursive Residuals

The straight lines represent critical bounds at 5% significance level
FIGURE 3.17 CUSUM TEST : INDONESIA, SECOND PERIOD Plot of Cumulative Sum of Recursive Residuals

The straight lines represent critical bounds at 5% significance level

FIGURE 3.18 CUSUMSQ TEST : INDONESIA, SECOND PERIOD Plot of Cumulative Sum of Squares of Recursive Residuals

The straight lines represent critical bounds at 5% significance level
echoed with the results by the sequential Chow test. Moreover, the instability problem of the money demand function in Japan and Korea for the first period is focused by these statistics as well.

### 3.5 Further Examination of the Money Demand Function

In this section, several specification issues for the money demand function will be investigated. First, the test statistic of normality against the alternative that the errors have a distribution of Pearson family proposed by Bera and Jarque (1981) is calculated. This test statistics is distributed as $ \chi^{2}(2) $ under the null hypothesis that the error term is normally distributed. Table 3.2 summarizes the results of this test. According to these test statistics, the null hypothesis of the normality of the regression residuals is not rejected in any case.

As a test of orthogonality assumption, a test statistic proposed by Hausman (1978) is calculated. This test statistic, comparing two estimators of Test statistics are shown in table 3.3. Null hypothesis is, however, not rejected at the 5% significance level in any cases.

Next the test statistic for homoscedasticity is given by a simple LM test of =0 in the auxiliary regression,

$$ \mathbf{E}\left(\mathbf{u}_{\mathrm{t}}^{2}\right)=\boldsymbol{\sigma}_{\mathrm{t}}^{2}=\boldsymbol{\sigma}^{2}+\gamma\left(\mathbf{y}_{\mathrm{t}}^{2}\right) $$

The calculated test statistics, though rather limited, are shown in table 3.4 along with P values. Though, null hypothesis of the homoscedasticity of the residuals is rejected at the 10% significance level in the second period for Japanese money demand function, those test statistics were found to be insignificant.

Finally to examine possible first order autoregressive conditional heteroscedasticity in the residuals, ARCH test statistic is reported. Table 3.5 includes test statistics which are distributed as $ \chi^{2}(1) $ . According to the test statistics, the null hypothesis are rejected in both periods for Korea and the second period for Japan.

Since possible first order autoregressive conditional heteroscedasticity was detected by these statistics, the money demand function for those periods are reestimated assuming first order autoregressive conditional heteroscedasticity. Estimated result of the second period for Japan is presented in the table 3.6. $ ^{22} $ The result at large echoes with the previous one.
TABLE 3.2: NORMALITY ASSUMPTION

Country	Japan	Korea	Indonesia
Estimation Period	1966:II	1973:II	1973:IV	1980:I	1977:III	1983:III
1973:I	1990:I	1979:IV	1990:I	1983:IV	1990:I
BERA-JARQUE STATISTICS	4.321	1.390	.511	1.601	2.413	.354
P-VALUE	.115	.499	.774	.588	.299	.838

TABLE 3.3: HETEROSCEDASTICITY TEST

Country	Japan	Korea	Indonesia
Estimation Period	1966:II	1973:II	1973:IV	1980:I	1977:III	1983:III
1973:I	1990:I	1979:IV	1990:I	1983:IV	1990:I
HETEROSCEDASTICITY TEST	.018	3.307	1.318	1.116	1.428	.001
P-VALUE	.893	.069	.251	.291	.232	.969

TABLE 3.4: ARCH TEST

Country	Japan	Korea	Indonesia
Estimation Period	1966:II	1973:II	1973:IV	1980:I	1977:III	1983:III
1973:I	1990:I	1979:IV	1990:I	1983:IV	1990:I
ARCH TEST	.836	5.203	4.835	6.252	.212	2.411
P-VALUE	.360	.023	.028	.012	.645	.121
TABLE 3.5: ARCH TEST

Country	Japan	Korea	Indonesia
Estimation Period	1966:II	1973:II	1973:IV	1980:I	1977:III	1983:III
1973:I	1990:I	1979:IV	1990:I	1983:IV	1990:I
ARCH TEST	.836	5.203	4.835	6.252	.212	2.411
P-VALUE	.360	.023	.028	.012	.645	.121

TABLE 3.6: ARCH MONEY DEMAND FUNCTION FOR JAPAN

COUNTRY	PERIOD	CONSTANT	GNP	INT	M/P(-1)	$ \overline{R}^{2} $	DW
JAPAN	1973:III-1990:I
-1.116	.252	-.025	.837	.998	1.27
(-3.91)	(4.550)	(-5.178)	(23.968)

See Table 3.1.