Keith Cuthbertson

THE DEMAND FOR MONEY: A DYNAMIC RATIONAL EXPECTATIONS MODEL*

This paper presents and estimates a model of the demand for money which explicitly incorporates foward-looking behavior. A multiperiod, rational expectations, quadratic costs of adjustment problem is solved using the discrete time calculus of variations to yield a money demand equation which is both foward-looking and contains a lagged dependent variable, and nests partial adjustment and error correction alternatives. The equation is estimated jointlywith a vector autoregression for the forcing variables, subject to cross-equation restrictions in an attempt to circumvent the R. E. Lucas_(1976) critique, on U. K. data for narrow money, MI. The results are encouraging. Copyright 1987 by Royal Economic Society.

Fixed investment decisions in UK manufacturing: The importance of Tobin's Q, output and debt

Abstract In a neoclassical intertemporal framework real investment is determined by Tobins marginal-Q. We develop this approach to include both agency costs of debt and regime changes, where in some periods the firm may be demand constrained. This leads to a ‘wedge’ between marginal and average-Q and in addition to the latter variable, investment depends on capital gearing and output. The model is used to explain UK fixed investment in the manufacturing sector 1968–1990 using an error-correction model and cointegration techniques. The statistical performance of the model, including parameter stability is satisfactory.

False Discoveries in UK Mutual Fund Performance

We use a multiple hypothesis testing framework to estimate the false discovery rate (FDR) amongst UK equity mutual funds. Using all funds, we find a relatively high FDR for the best funds of 32.8% (at a 5% significance level), which implies that only around 3.7% of all funds truly outperform their benchmarks. For the worst funds the FDR is relatively small at 7.6% which results in 22% of funds which truly underperform their benchmarks. For different investment styles, this pattern of very few genuine winner funds is repeated for all companies, small companies and equity income funds. Forming portfolios of funds recursively for which the FDR is controlled at a ‘acceptable’ value, produces no performance persistence for positive alpha funds and weak evidence of persistence for negative alpha funds.

Explaining movements in UK stock prices

Abstract We examine movements in aggregate UK stock prices by decomposing the variance of unexpected real stock returns into components due to revisions in expectations of future dividends, discount rates, and the covariance between the two. The contribution of news about future discount rates is about four times that of news about future dividends, with no significant covariance between them. Our analysis of excess returns uncovers a positive covariance between news about dividends and news about real interest rates. Since these two elements have opposite effects on current stock prices, their combined effect is negligible. Persistence in expected returns, as well as predictability, are found to be important in explaining stock price movements.

Buffer-Stock Money: An Appraisal

In the recent literature there has been a revival of interest in the role of money as a buffer stock, that is, as an asset that acts as a ‘shock absorber’ enabling agents temporarily to postpone otherwise costly adjustments to alternative economic variables such as employment, investment and output. In broad terms this approach has been prompted by problems encountered in trying to estimate stable ‘conventional’ demand for money functions, in understanding the ‘long and variable lags’ of monetary policy and in the phenomenon of interest rate (and hence exchange rate) overshooting under monetary targets. Running in tandem with the buffer-stock notion has been the wide application in macroeconomics generally of the rational expectations (RE) hypothesis and ‘market clearing’ RE models of the New Classical School, where a key distinction is drawn between anticipated and unanticipated events. Although the buffer-stock approach is often dubbed ‘disequilibrium money’, we argue below that certain buffer-stock models are not necessarily inconsistent with RE and, indeed, that one can usefully combine the two approaches. There is also a recurring debate in the literature (Laidler, 1982) concerning the interpretation of estimated demand-for-money functions: are they demand functions, or do they represent reparameterised real balance equations (where causation runs from money to the arguments of the demand for money function)? The notion that buffer holdings of money are voluntarily held in the short run and then dissipated in a slow real balance effect clearly has attractions both as an explanation of ‘temporal instability’ in demand for money functions and in contributing to an explanation of ‘long and variable lags’.

Money demand in the czech republic since transition

We analyse the demand for money since the “break up” of the Czech-Slovak Republics at the beginning of 1993 and for the aggregates M0, Ml, and M2 using monthly data. Due to the widespread use of foreign currency in formally centrally planned economies, we also investigate the issue of currency substitution. Because of our relatively small sample period the Johansen cointegration approach is not used and instead we use the general to specific methodology in a single equation framework. Previous empirical evidence on money demand in Eastern Europe, and specifically Czech Republic, has been mixed. Both graphical and empirical results suggest that any currency substitution was a one-off event due to increased uncertainty at the end of 1992 at the time of the monetary dissolution. Certainly, currency substitution in the Czech Republic is not as strong as has been found in other former centrally planned economies. However, our results do indicate that Czech National Bank may have to take account of foreign interest rates when interpreting movements in the monetary aggregates.

Interest Rates in Germany and the UK: Cointegration and Error Correction Models

The authors test the expectations hypothesis (EH) of the term structure using U.K. and German weekly data on short dated instruments with maturities up to one year. For both data sets comprising k interest rates the authors find that the rank of the cointegrating space is (k - 1); but they can only accept that the cointegrating parameter estimates are of the form (-1, 1, 0,...) etc. when considering bilateral combinations of interest rates. When the authors test the joint null that the set of (k - 1) spreads forms a basis for the cointegration space, this is rejected. However, the point estimates of the cointegration parameters are close to unity and there is no diminution in outside sample forecasting performance of the ECM equations when the spread restrictions are imposed. On balance, one might conclude that the EH is not grossly at variance with the data. Copyright 1998 by Blackwell Publishers Ltd and The Victoria University of Manchester

Local authority fiscal policy and urban employment

An econometric model of the determinants of employment in urban local authority areas is described, with particular reference to the effects of non–strategic local authority fiscal behaviour. The data base for the study is a 1971 cross–section of 32 London boroughs. The estimated model is used to assess the contribution of changes in local authority taxing and spending decisions to changes in London employment 1966–71. The study finds evidence of considerable crowding–out effects, with an average of one quarter of the borough employment decline in the period being attributed to the local fiscal policies pursued, ceteris paribus

Excess volatility and efficiency in French and German stock markets

Abstract In this paper, we analyse whether the French and German stock markets can be classified to be efficient or whether they exhibit excess volatility. We assess efficiency in each market by employing the VAR methodology of Campbell and Shiller (Campbell, J.Y., Shiller, R.J., 1988b. The dividend–price ratio and expectations of future dividends and discount factors. Rev. Financ. Stud. 1, 195–228) and adopting two alternative assumptions regarding equilibrium expected returns. The first model assumes that equilibrium expected excess returns are constant, while the second model assumes that equilibrium returns depend upon a time varying risk premium which varies with the conditional expectation of the return variance (i.e. the CAPM). We find that the model which assumes constant excess returns is clearly rejected for both France and Germany. However, the volatility (CAPM) model provides some evidence for efficiency.

“The case of the missing money” and the Lucas critique

The paper examines the missing money episode in terms of the Lucas critique. A model of the demand for U.S. narrow money incorporating expectations is estimated together with auxiliary expectations-generating equations for the independent variables prices, expenditure, and interest rates. Instability in the expectations generation equations around the missing money period is consistent with the instability found in conventional “backward looking” partial adjustment models. However, the forward looking model of the demand for money is statistically acceptable once account is taken of the shift in the expectations-generating equations.