SSRN-id1004596 - Revista de Econom ia del Rosario Tests of...

Electronic copy available at: http://ssrn.com/abstract=1004596
Revista de Econom´ ıa
del Rosario
Tests of the functional form, the substitution effect, and
the wealth effect of Mexico’s money demand function
Yu Hsing
*
College of Business, Southeastern Louisiana University, USA.
Received: October 2006 – Approved: January 2007
Abstract. M1, M2, and M3 demands in Mexico are positively influenced by
output and stock prices and negatively associated with the saving rate, the
U.S. interest rate, and the expected inflation rate. Peso depreciation affects
M1 demand negatively and M2 and M3 demands positively. The log-linear
form cannot be rejected for M1 demand and can be rejected for M2 and M3
demands, while the linear form can be rejected for M1, M2, and M3 demands.
The CUSUMSQ test shows that M1, M2, and M3 demands are stable; while
the CUSUM test indicates stability in M1 and M3 demands and instability in
M2 demand.
Key words: Box-Cox transformation, currency substitution, wealth effect,
stability tests.
JEL classification: E41, F41, O54.
Resumen. Las demandas M1, M2 y M3 en M´ exico son influenciadas positi-
vamente por el producto y el precio de las acciones, y est´ an asociadas negati-
vamente con la tasa de ahorro, la tasa de inter´ es estadounidense y la tasa de
inflaci´ on esperada. Por su parte, la depreciaci´ on del peso afecta negativamente
la demanda M1 y positivamente las demandas M2 y M3. La forma log-lineal
no puede ser rechazada para la demanda M1 y puede ser rechazada para las
demandas M2 y M3, mientras que la forma lineal puede ser rechazada para
las demandas M1, M2, y M3. La prueba CUSUMSQ muestra que las demandas
M1, M2 y M3 son estables; mientras la prueba CUSUM indica estabilidad en
las demandas M1 y M3 e inestabilidad en la demanda M2.
Palabras clave: transformaci´ on de Box-Cox, sustituci´ on monetaria, efecto
riqueza, pruebas de estabilidad.
Clasificaci´ on JEL: E41, F41, O54.
*
E-mail: [email protected]
Rev. Econ. Ros. Bogot´ a (Colombia) 10 (1): 43–53, junio de 2007

Electronic copy available at: http://ssrn.com/abstract=1004596
44
T
ESTS OF
M
EXICO’S MONEY DEMAND FUNCTION
1. Introduction
During the 1994-95 crisis, the Mexican peso suffered a substantial depre-
ciation of 121.7%, the deposit rate rose to a high of 57.5%, the stock price
plunged 43.5%, and the inflation rate rose 48.4%. Largely due to these de-
velopments, M1 declined from 145.1 billions in 1994.M12 to 109.7 billions in
1995.M5, while M2 and M3 were relatively stable or rising. It is significant to
examine the demand for money for Mexico to have a better understanding of
its behavior and impacts on the country’s economic activities. This paper has
several focuses. First, financial stock prices in Mexico have advanced a great
deal in the last decade and may affect the demand for money negatively due to
the substitution effect or positively due to the wealth effect (Friedman, 1988).