The stability of money demand function in Japan: Evidence from rolling cointegration approach

The main purpose of this study is to re-investigate the stability of Japanese M2 money demand function over the period of 1960:Q1 to 2007:Q2. This study propose to incorporate the rolling regression approach into the bounds testing procedure for cointegration within the autoregressive distributed lag (ARDL) framework to search for the stability of money demand function in Japan. This study, in general, confirms that real M2 money demand and its determinants, real income and interest rates are cointegrated within the entire sample period. In line to that, the CUSUM and CUSUM of Squares tests show that the money demand function is stable over the analysis period. However, the evidence of rolling ARDL cointegration test implies that Japanese M2 money demand is not stable due to a series of changes in the Japanese monetary policy environment. The finding of this study is vital for policymakers in formulating an appropriate macroeconomic policy. Owing to the low power of CUSUM and CUSUM of Squares tests in the presence of lagged dependent variable(s), this study propose to use the rolling cointegration test to re-investigate the stability of money demand function in Japan.