Does Interest Rate Volatility Affect the US M1 Demand Function? Evidence from Cointegration

Abstract

The long-run demand for US real M1 in the post Second World War period (1954-96) is investigated. The empirical investigation is conducted by means of Johansen multivariate cointegration tests and error correction models. Results show that a stationary long-run M1 demand function is only found when the interest rate volatility or the inflation rate volatility is included in the function. The conditional variance estimate from the GARCH(1, 1) model is used as volatility in the empirical work. Results from the error correction models indicate causality between real M1 and its determinants, including interest rate (and inflation rate) volatility. A significant presence of interest rate volatility in the money demand function may affect economic performance and monetary policy. Copyright 1999 by Blackwell Publishers Ltd and The Victoria University of Manchester