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

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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
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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).
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