Generalized Functional Forms and Demand for Money in an Open Economy: The Case of the United Kingdom

Abstract

The purpose of this paper are twofold: first, to apply a Box-Cox model to the UK money demand relationship within an open economy framework in order to empirically investigate the proper functional form supported by the data in this general setting. Secondly, to test for the proper scale variable in the UK money demand function within the open economy Box-Cox specification. These improvements enhance the accuracy of our measures of monetary and fiscal policy effects and our understanding of the interdependence between different economies. The empirical results derived here reject the restrictive linear and log specifications in favour of the general Box-Cox model under both income and consumption-based money demand specifications. The traditional income-based model, however, escapes unharmed from the challenge put forward by Mankiew and Summers (1986).