Monetary anticipations and the demand for money: Some evidence for the U.K.

The role of money as a buffer stock has been widely debated in the recent literature. One strand of this hypothesis is the view that money supply shocks are temporarily held as additional money balances. This mechanism mitigates the degree of (interest rate) overshooting when conventional demand functions are inverted under the assumption of independent movement in the money supply. We used a structural time series model due to Harvey and Todd [1983] to generate a series for anticipated money. The advantages of this procedure are, firstly, that it implies forecasting behaviour on the part of economic agents which may be more plausible than that implied by the use of a more specific ARIMA model and, secondly, that problems of appropriate model selection are avoided. Using U.K. data on Ml and a stable money demand specification belonging to a widely used class of functions, we find support for the Carr-Darby hypothesis. That is, we find that unanticipated changes in the money supply are partially taken up in additional money balances, whereas expected changes do not influence real money balances. This finding has clear implications for the appropriate conduct of monetary policy.