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.