Question 1

Why is the U.S. money demand function unstable after 1980?

Accepted Answer

The instability is a measurement artifact of simple-sum aggregation, not a change in households' preferences for monetary assets. Chen and Valcarcel (2024) show that with Barnett (1980) Divisia aggregates, the cointegration between money and output survives straddling the 1980 DIDMCA break. Simple-sum M2 and M3 treat interest-bearing deposits as perfect substitutes for non-interest-bearing currency, which breaks down after 1980 deregulation legalizes interest on checkable accounts. Andrews-Ploberger and Bai-Perron structural break tests locate the break around 1980:Q2, but the relationship itself reconstitutes in the post-1980 subsample when Divisia user costs are used as the opportunity cost. The paper labels this the measurement-not-preference verdict.

Question 2

Does Divisia money demand remain stable across the 1980 DIDMCA break?

Accepted Answer

Yes. Chen and Valcarcel (2024) show the cointegration between Divisia M2 (or M3) and its own user cost holds in both the pre-1980:Q2 and post-1980:Q2 subsamples, across all four Johansen (1995) deterministic-trend specifications. Simple-sum M2 loses cointegration with the user cost in three of four Johansen specifications post-1980; simple-sum M3 never cointegrates post-1980. This aligns with Belongia and Ireland (2019), who estimate a stable Divisia M2 and MZM demand over 1967-2019.

Question 3

Does the T-bill yield cointegrate with monetary aggregates after the Great Financial Crisis?

Accepted Answer

No. Chen and Valcarcel (2024) show the three-month T-bill yield loses cointegration with Divisia M3 and Divisia M4 in the post-2008:Q3 subsample under all Johansen specifications. The yield was pinned near zero for roughly seven years. The user costs of Divisia M3 and M4, which compressed but stayed well above zero (Mattson and Valcarcel 2016), continue to cointegrate with their respective aggregates post-GFC under all specifications, with the correct sign and larger elasticity estimates than in the pre-GFC subsample.

Question 4

Are Divisia user costs better than the T-bill yield as the opportunity cost of holding money?

Accepted Answer

Yes. On theoretical grounds, the user cost derived by Barnett (1978) is the textbook opportunity cost of each monetary asset; the T-bill yield is the price of a substitute. On statistical grounds, Chen and Valcarcel (2024) show Divisia user costs maintain cointegration with Divisia M2 and M3 across the 1980 and 2008 structural breaks, while the T-bill yield does not. DF-GLS unit-root tests also indicate Divisia user costs are level-stationary around a deterministic trend while the T-bill yield is not. This is the user-cost sufficiency for money demand result.

Question 5

Which individual monetary assets cointegrate with their own user costs?

Accepted Answer

Currency, demand deposits, savings deposits, small and large time deposits, repurchase agreements, institutional money-market funds, and the aggregate of commercial paper plus T-bills all cointegrate with their own CFS user costs in at least two of four Johansen specifications, with the correct sign. Chen and Valcarcel (2024) report that of 40 estimates (10 asset pairs x 4 Johansen specifications) using the double-log form, 29 show the expected negative user-cost elasticity with the correct sign. The CFS user-cost data for individual components comes from Barnett, Liu, Mattson, and van den Noort (2013). This is the granular money-demand cointegration result.

Question 6

Should I use semi-log or double-log money demand specification for Divisia aggregates?

Accepted Answer

Use the Cagan (1956) semi-log form for the full sample and the pre-GFC sample. Use the Meltzer (1963) double-log form when the sample includes the post-2008 zero-lower-bound period, since Bae, Kakkar, and Ogaki (2006) show it better accommodates the liquidity-trap region. Chen and Valcarcel (2024) find Divisia M2/M3 demand cointegrates under both forms in the full sample; the double-log form is preferred for samples that include the ZLB.

Question 7

Is money demand instability evidence of a structural change in preferences?

Accepted Answer

No. Chen and Valcarcel (2024) conclude that 'the instability of money demand is a matter of measurement rather than a consequence of a structural change in agents' preference for monetary assets.' The preference-change reading, implicit in Friedman and Kuttner (1992), is undermined once proper aggregation and proper opportunity costs are used. This reading is reinforced by Belongia (1996), Lucas and Nicolini (2015), Barnett, Ghosh, and Adil (2022), and Jadidzadeh and Serletis (2019).

Dimension	Simple-sum + T-bill	Simple-sum + user cost	Divisia + T-bill	Divisia + user cost
Theoretical coherence	Weak. Equal weights on heterogeneous assets; T-bill is the price of a substitute, not of money.	Weak on quantities; coherent on price.	Coherent on quantities; weak on price.	Fully coherent. Barnett (1980) aggregation paired with Barnett (1978) user cost.
Full-sample cointegration (M2)	Fails in both functional forms.	Intermittent — cointegrates under some Johansen specs, not others.	Robust. Cointegrates under all four Johansen (1995) specifications.	Robust. Cointegrates under all four specifications, correct sign, both semi-log and double-log.
Post-1980 subsample (M2)	Fails in semi-log form. Wrong sign in some trend specs.	Fails in 3 of 4 Johansen specifications.	Cointegrates under constant specs only; wrong sign under trend specs.	Robust across all specs, correct sign.
Post-GFC subsample (M3, M4)	Not applicable — simple-sum abandoned for this era.	Not applicable.	Fails under all specs (T-bill stuck near zero).	Robust across all specs, with higher elasticity estimates than pre-GFC.
Asset-level (granular) cointegration	Most components fail or show wrong sign with T-bill.	Not the paper’s focus.	Most components fail or show wrong sign.	29 of 40 specifications show correct sign (Chen & Valcarcel 2024 ).
What it takes as the break event	Money demand itself breaks in 1980.	Break arises from quantity side.	Break arises from price side (T-bill loses information post-1980 and post-2008).	No break — measurement-not-preference verdict. Apparent instability is an aggregation/measurement artifact.
Named concept	—	—	—	User-cost sufficiency for money demand · Granular money-demand cointegration (Chen & Valcarcel 2024 )

Cointegration | Robin Chen

A Granular Investigation on the Stability of Money Demand

The Instability of U.S. Money Demand After 1980 Is a Measurement Artifact

Key Concepts

Q1. Why is the U.S. money demand function unstable after 1980?

Four Measurement Combinations for U.S. Money Demand

Q2. Does Divisia money demand remain stable across the 1980 DIDMCA break?

Q3. Does the T-bill yield cointegrate with monetary aggregates after the Great Financial Crisis?

Q4. Are Divisia user costs better than the T-bill yield as the opportunity cost of holding money?

Q5. Which individual monetary assets cointegrate with their own user costs?

Q6. Should I use semi-log or double-log money demand specification for Divisia aggregates?

Q7. Is money demand instability evidence of a structural change in preferences?

Data and Code

Citation