Demand for Real Balances (m^d)

The demand for real balances is assumed to depend on real non-oil income (y), the expected oil wealth (f), and the domestic (i) and foreign (i_f) interest rate(s).⁵ The relationship between expected oil wealth and the demand for money represents a confidence or psychic factor, as discussed earlier, but it is also consistent with Friedman’s (1959) hypothesis that demand for real balances depends on permanent rather than actual income. The inclusion of both non-oil income and expected oil wealth in the demand for money equation also permits a test of the plausible hypothesis that the elasticity of demand for money with respect to oil should differ substantially from that with respect to non-oil income, reflecting the dominant role of the government in oil-related transactions.

In a relatively open economy such as that of Venezuela, both foreign and domestic interest rates (i_f)and i, respectively) should be included in the demand for money equation to represent the yield on foreign and domestic assets (Hamburger (1977)). In a completely open economy these assets are perfectly substitutable, so that the movements in their yields are perfectly correlated, and there is no need to include both interest rates in the equation. Because the degree of openness is an empirical question, however, the demand function is specified to include both interest rates (the time subscripts t have been suppressed throughout the paper for ease of presentation):

The actual stock of real balances is assumed to adjust with a lag to the desired stock:

where μ is the speed of adjustment and A is the first difference operator:

The above relationships result in the following estimating equation:

Where a₂, a₃, a₄, a₆> 0 and a₅< 0.

Private Consumption Expenditures (con)

The level of aggregate private consumption rises whenever there is an excess private demand for consumer goods:

where con^d denotes the desired level of private consumption. It is assumed to vary directly with non-oil real income (y) and expected oil wealth (f), and inversely with the level of monetary disequilibrium in the previous period:

where EFD denotes the level of disequilibrium in the money market, as defined later in this section (in the subsection “Monetary Dis equilibrium”). Eliminating con^d from the above relationships yields the estimating equation:

Where b₂> 0, b₃> 0, b₄< 0, and a₅< 0.

Private Investment (KF)

The desired level of real private capital stock (K/P)^d is assumed to be a linear function of real non-oil income (Y/P), expected real oil wealth (F/P), and the opportunity cost of capital (q):

q is measured by the rental wage ratio,

where W represents the nominal wage index and ∏ denotes the rate of change in capital goods prices.

An expansion in non-oil income would raise the desired capital stock, whereas an increase in the rental wage ratio would lower it by encouraging substitution of labor for capital. However, the impact of an increase in expected oil wealth on desired private capital stock is ambiguous. Because the immediate beneficiary of higher income from oil is the government, the direction of the effect would depend on the expected pattern of government expenditure. That is, the desired private capital stock may rise if government expenditures are viewed as complementary to private investment (as could be the case with government expenditures channeled to infrastructural investment). The desired private capital stock will decline if government expenditures are expected to be of a competing nature, concentrated on projects usually undertaken by the private sector. The sign of the coefficient of F/P is therefore indeterminate a priori.

In each period the actual level of the capital stock adjusts partially to the desired level:⁶

The level of real gross fixed capital formation (KF/P) is given by

where DEP denotes depreciation of the capital stock, assumed to be a constant proportion Θ of the capital stock in the previous period; that is,

The estimating relationship for KF/P is thus given by

Where u₁>0, u₂<0, and u₄ = Θ - u.

Domestic Price Inflation

The domestic price level (p) is assumed to be a weighted average of the prices of traded and nontraded goods (p^t and pⁿ, respectively):

Movements in prices of nontraded goods result from variations in money market disequilibrium or from changes in the excess of demand over potential supply in the goods market (ECD):⁷

If potential output is assumed to be proportional to the real capital stock (k), one can write

where y^d represents the level of demand in the goods market. These relationships give the following estimating equation for domestic inflation:

Where c₂>0, c₃ =-c₂ < 0, and c₄ < 0.

Growth of Non-Oil Output (y)

The supply of non-oil output (y) responds to excess demand in the commodity market, to the disequilibrium in the money market (with a time lag), and to relative prices:

An improvement in the terms of trade in favor of nontraded goods could be expected to stimulate the supply of non-oil output because nontraded goods make up the bulk of domestic non-oil production. However, the increase in the relative price of nontraded goods may shift the consumption pattern away from such commodities, thus inducing a cutback in production. The sign of the coefficient d₄ is therefore indeterminate a priori.

After rearrangement, the estimating equation can be derived as follows:

Where D₂>0, D₃< 0, and 0 > D₅=-d₂/(1+d₂)> -1.

The demand for domestic non-oil output (Y^d) comprises public (G) and private demand for goods and services and demand for non-oil exports(Xⁿn):

Imports (im)

The level of actual real imports (im) rises whenever there is excess demand for imports:

The desired level of imports (im^d) is assumed to depend on planned private expenditures (e), on government real expenditures (g), and on the relative prices of traded and nontraded goods:

The variables e and g enter the import function separately to account for the difference in the import content of private and government expenditures. The underlying demand for private expenditure is composed of desired consumption and planned investment:

In the present formulation, the planned and actual levels of investment are assumed to be equivalent. In other words, plans to adjust to the desired capital stocks at a given speed are assumed to be fully realized.

The following equation can thus be derived:

Where k₂>0, k₃>0, k₄>0, and 1≥k₅=1-k₀≥0.

Government Revenues (GR) and Expenditure (G)

Government revenues (GR) consist of oil revenues (OR) and non-oil revenues (DR):

Non-oil revenues are related to non-oil income:

Given the exogeneity of the price and demand for oil, the governments of oil producing countries can exercise little discretionary control over the bulk of their revenues, particularly in the short run. As a result they have attempted, to a larger extent than other countries, to adjust their expenditures in line with revenues. Indeed, studies of the Islamic Republic of Iran and of Indonesia have shown that the level of government expenditure in each period is established in these countries in such a way as to move toward a balanced budget over time (Aghevli and Sassanpour (1982) and Sassanpour (1985)). Adopting such an assumption allows the following relationship to be specified:

which results in the estimating equation

Non-Oil Exports (Xⁿ)

Non-oil exports are determined as a residual from the income identity:⁸

where ΔINV is the change in inventories, and DOC is domestic consumption of oil. Non-oil exports are thus affected by developments on both the demand and supply sides of the economy.

Capital Flows (PKI)

Capital flows usually respond to a variety of factors that no single relationship can adequately capture. Nevertheless, in the present model it is assumed that the differential in expected returns on domestic and foreign assets and changes in domestic and foreign incomes bring about changes in desired asset holdings, thus generating capital flows. Because most capital movements are to and from the United States, foreign variables refer to that country:

where

and YUS denotes nominal U.S. GDP. Note that estimating a net capital flow equation of the type specified assumes that foreign and domestic assets are not perfect substitutes.⁹ If assets are perfectly substitutable, this equation should be replaced by an interest arbitrage equation linking i and i_f.

The Money Supply Identity

As noted earlier, the impact of government operations on domestic liquidity can be measured by the government’s domestic budget balance; that is, by the difference between domestic revenues and domestic expenditures (GDE). In other words, even if the overall budget is in balance or in surplus, the net impact of the government’s operations can be expansionary. It is more useful, therefore, to write the money supply identity in terms of the domestic budget balance, as follows:¹⁰

where PIM denotes private imports, CP stands for credit to the private sector, and BOP represents a residual item in the balance of payments. Because complete data are not available for the government’s domestic expenditures (GDE), the above identity is rearranged in terms of total government expenditure and total imports (Aghevli and Sassanpour (1982)):

In equation (15), BOP is exogenous, and all the other variables except CPare determined from the equations specified earlier. Therefore, this relationship now determines the flow of credit to the private sector.

Monetary Disequilibrium

Two measures of monetary disequilibrium have been used in the literature. The first embodies a stock concept, whereby disequilibrium is measured in terms of the deviation of the actual stock of real balances from demand:¹¹

where ESD is the excess stock demand for real balances.

This concept ignores the role that domestic credit expansion during the period plays in closing the real balance gap. Another measure, proposed by Blejer (1977) and Sundararajan (1986) among others, focuses on the concept of “flow disequilibrium,” which makes appropriate allowances for the authorities’ attempt to fill the real balance gap through credit creation. Accordingly, the flow excess demand (EFD) is defined as

where MM is the money multiplier and ΔDA refers to the change in the net domestic assets of the central bank during the period.

The choice of the disequilibrium concept has important implications for the dynamic effects of monetary policy in empirical models dealing with small open economies. In this study, the disequilibrium concept represented in equation (16) is used.

Expected Income from Oil Extraction

The expected oil wealth (F) in each period is defined as

where

• PV = the present value of the streams of income derived from oil over the lifetime of the resource

• d= the rate of discount

• Q_i= the rate of oil exploitation at time i

• π_i= the price of oil at time i

• T= the time of depletion of the oil stock

• E_t= the expectations operator.

Because T is unknown, this relationship cannot be readily incorporated in the model. For empirical purposes, a simplified version could be derived on the assumption that the expected rate of oil price inflation is equal to the discount rate. It is well known from the theory of exhaustible resources that the optimal rate of extraction is determined at the point where the marginal productivity of the resource in all its uses is equalized (see Hotelling (1931) and Davarajan and Fisher (1981)). The expected rate of oil price inflation represents the marginal productivity of oil if left underground, whereas the rate of return on financial assets (or the interest rate) represents the marginal productivity of the resource if invested in financial assets. Thus, at the optimal rate of extraction, the rate of oil price inflation is equal to the interest rate.

In contrast, if expected oil price inflation is higher than the rate of interest, then the optimal policy dictates keeping the resource underground; if it is lower, no equilibrium rate of extraction will exist because it would be optimal to exhaust the resource instantaneously.¹² Assuming that the social discount rate is equal to the rate of interest,¹³ and denoting the rate of oil price inflation in period i by r_i, one can write

where S is the stock of proven oil reserves in time t. Assuming static oil price expectations, E(π_t)=π_t-1, the following relationship is obtained:

This simple relationship represents the confidence or wealth effect of natural resource availability. It also embodies the concept of exhaustibility of oil (since S_t is declining over time), so that this important feature of the oil producing countries is built into the model, albeit in an admittedly crude fashion.

The Dynamic Process

To trace the dynamic process embodied in the model, consider the effect of an increase in F brought about through a resource discovery, so that oil revenues do not necessarily rise immediately.¹⁴ If one abstracts from the accompanying leads and lags, the immediate confidence effect of higher expected wealth directly increases demand for real balances and private consumption expenditures and also influences private investment. These in turn will generate opposing forces that exert both upward and downward pressures on the level of income and prices (as explained in the next paragraph), so that the final outcome cannot be established a priori and needs to be determined empirically.

Initially, the higher demand for money will widen the real balance gap (EFD), since μ < 1. This effect will depress the prices of nontraded goods¹⁵ and, hence, both imports and domestic inflation. The larger monetary disequilibrium will also dampen private demand for consumer goods and depress the growth of non-oil income. The excess of demand for non-oil commodities over potential output will then decline, further depressing nontraded goods prices and domestic inflation.¹⁶

Thus, through its impact on demand for real balances alone, an increase in expected real oil wealth would eventually lead to lower domestic inflation and income; it is also likely to lead to an improvement in the current account of the balance of payments because imports decline while exports remain unchanged. The overall balance of payments may also improve if capital outflows—which result, according to equation (13), from a decline in income growth—are not too large.

These results do not, however, constitute the final outcome of an increase in F, because the larger F also stimulates private demand for goods and services (con^d). Consequently, aggregate demand (y^d) rises relative to supply, putting upward pressure on the prices of nontraded goods and dampening the demand for real balances. A lower monetary disequilibrium will then result that will help to weaken or offset the feedback effects generated through the initial impact of the larger expected oil wealth on demand for real balances.

The net effect of these forces on the prices of nontraded goods will change relative prices. Given the fixed exchange rate, a decline (increase) in the prices of nontraded goods while the level of traded goods prices remains unchanged will result in reduced (increased) demand for imports. Any change in relative prices will also have an impact on domestic output, the direction of which is ambiguous a priori (as discussed earlier). The net result will feed into the dynamic system described above, strengthening or weakening some of the feedback effects. The final outcome of the movements in the variables depends on leads and lags (which were ignored in the discussion above) as well as on the relative speeds of adjustment and the strength of impact multipliers. These factors also determine the stability characteristics of the system. The eventual outcome for non-oil income, public and private expenditures, and imports will determine GDP and non-oil exports. The capital account as well as the overall balance of payments outcome will then be established, and the level of credit to the private sector will be determined by the money supply identity.¹⁷

The distinguishing characteristic of the dynamic process embodied in this model can best be seen with respect to the impact of an increase in oil production (rather than in oil wealth). In contrast to the earlier work on oil producing countries, where an increase in oil production usually leads to a rise in prices and non-oil output, in the present model the impact of an increase in oil production on prices and on non-oil output is ambiguous. The expansion of oil output results in lower availability of the resource (that is, in a smaller S), and thereby in smaller expected oil wealth F. This outcome will tend to depress domestic output and prices, provided that the impact of the oil wealth effect on private expenditures is stronger than its impact on demand for money, as discussed above.¹⁸ In contrast, the expansion in oil revenues arising from the larger output will raise government expenditures, which may serve to reverse this trend. The overall impact is therefore not clear a priori.

The Confidence Effect of Oil Wealth

The estimation results clearly indicate the existence of an oil wealth effect on the behavior of the economic agents, an aspect that has been neglected in previous analyses of the economies of major oil producers. The variable f (or F) is highly significant in all the equations where it appears: those for the demand for money, private consumption, and private investment. As expected, both money demand and private consumption respond positively to changes in expected oil wealth. A 1 percent increase in the expected oil wealth, everything else remaining equal, eventually raises both the real demand for money and private consumption by 0.2 percent. Because demand for money is stimulated by resource availability, expansionary monetary policy would be less inflationary in the presence of the oil wealth effect than in its absence.

Table 3.

Estimated Model

Note: Figures in parentheses are t-ratios: R² is the adjusted coefficient of determination; DW is the Durbin-YVatson statistic H is the Durbin H-statistics and SEE is the standard error of the estimate.

¹The domestic interest fare was deleted from this equation because it did not prove to he significant and its inclusion did not improve the standard error of the equation. Moreover, since bclivares have been stable in relation to the U.S. dollar for almost all of the estimation period, the expected exchange rate change has been assumed to be aero. The foreign interest rate was proxied by the three- month U.S. Treasury bill rate. Various formulations of actual and expected inflation were also included in this equation to reflect the opportunity cost of holding money instead of real assets but were dropped because their estimated coefficent was found invariably to carry the wrong sign, to be statistically insignificant, or to lead to unstable simulations. This does not necessarily imply, of course, that this opportunity cost of holding money is irrelevant to the money demand function in Venezuela only that the mechanism for its measurement is more complicated.

2 Corrected for autocorrelation by the Cochrane-Orcutt transformation.

Table 3.

Estimated Model

item	Estimated Equation
Demand for real balances (equation (1))1	$\begin{array}{c}m=\underset{(-4.712)}{8.362}+\underset{(4.457)}{1.228}y+\underset{(2.894)}{0.154}f-\underset{(-1.701)}{0.011}{i}_f+\underset{(2.021)}{0.327}{m}_{t-1}\\ \begin{array}{cc}\begin{array}{c}{\overline{R}}^2=0.992\end{array}& \begin{array}{cc}H=0.335& SEE=0.045\end{array}\end{array}\end{array}$
Real private consumption (equation (2))	$\begin{array}{c}con=-\underset{(-2.784)}{0.632}+\underset{\left(4.866\right)}{0.229}y+\underset{\left(2.900\right)}{0.063}f-\underset{(-0.592)}{0.000001}EF{D}_{t-1}+\underset{\left(9.329\right)}{0.680}{con}_{t-1}\\ \begin{array}{cc}\begin{array}{c}{\overline{R}}^2=0.997\end{array}& \begin{array}{cc}H-1.183& SEE=0.019\end{array}\end{array}\end{array}$
Real private investment (equation (3))	$\begin{array}{c}KF/P=-\underset{(-2.101)}{16459.4+}\underset{\left(4.248\right)}{1.071}(Y/P)-\underset{(-2.493)}{0.01}(F/P)-\underset{(-1.349)}{0.159}{(K/P)}_{t-1}-\underset{(-2.666)}{1125.76}q\\ \begin{array}{cc}\begin{array}{cc}{\overline{R}}^2=0.924& DW=1.449\end{array}& SEE=1586.0\end{array}\end{array}$
Domestic inflation (equation (4))	$\begin{array}{c}\mathrm{\Delta }p=\underset{\left(5.403\right)}{0.115}+\underset{\left(3.385\right)}{0.265}\mathrm{\Delta }{y}^d\underset{(-7.243)}{-0.410}\mathrm{\Delta }k\underset{(-0.967)}{-0.000001}\mathrm{\Delta }EFD\underset{\left(0.803\right)}{+0.034}\mathrm{\Delta }{p}^t\\ \begin{array}{cc}\begin{array}{cc}{\overline{R}}^2=0.966& DW={2.140}^2\end{array}& SEE=0.019\end{array}\end{array}$
Growth of non-oil income (equation (5))	$\begin{array}{c}\mathrm{\Delta }y=\underset{(-2.052)}{+1.545}+\underset{(5.078)}{0.466}{y}^d+\underset{(0.882)}{0.017}(p^n-p^t)\underset{(-0.141)}{-0.000001}EF{D}_{t-1}-\underset{(-4.279)}{0.622}{y}_{t-1}\\ \begin{array}{cc}\begin{array}{cc}{\overline{R}}^2=0.795& DW=2.342\end{array}& SEE=0.02\end{array}\end{array}$
Imports (equation (8))	$\begin{array}{c}im=\underset{(-8.639)}{-5.585}+\underset{\left(1.510\right)}{0.316}e+\underset{\left(6.102\right)}{0.835}g\underset{\left(13.859\right)}{+0.878(}{p}^n-p^t)+\underset{\left(3.882\right)}{0.418}i{m}_{t-1}\\ \begin{array}{cc}\begin{array}{cc}{\overline{R}}^2=0.993& H=-0.562\end{array}& SEE=0.047\end{array}\end{array}$
Government domestic revenues (equation (10))	$\begin{array}{c}dr=\underset{(-8.007)}{-8.608}\underset{(16.980)}{+1.605}y\\ \begin{array}{cc}\begin{array}{cc}{\overline{R}}^2=0.954& DW={1.930}^2\end{array}& SEE=0.069\end{array}\end{array}$
Government expenditure (equation (11))	$\begin{array}{c}g=\underset{(4.499)}{0.304gr}\underset{(10.099)}{+0.698}{g}_{t-1}\\ \begin{array}{cc}\begin{array}{cc}{\overline{R}}^2=0.976& H=0.158\end{array}& SEE=0.068\end{array}\end{array}$
Private capital flows (equation (13))	$\begin{array}{c}PKI=-\underset{(-2.223)}{7121.360}+\underset{\left(3.073\right)}{1738.04(i}-i_f)+\underset{(2.333)}{0.157}\mathrm{\Delta }GDP+\underset{(2.500)}{0.009\mathrm{\Delta }}YUS-\underset{(-10.733)}{27070.8D}\\ \begin{array}{cc}\begin{array}{cc}{\overline{R}}^2=0.919& DW={2.073}^2\end{array}& SEE=2920\end{array}\end{array}$

Note: Figures in parentheses are t-ratios: R² is the adjusted coefficient of determination; DW is the Durbin-YVatson statistic H is the Durbin H-statistics and SEE is the standard error of the estimate.

¹The domestic interest fare was deleted from this equation because it did not prove to he significant and its inclusion did not improve the standard error of the equation. Moreover, since bclivares have been stable in relation to the U.S. dollar for almost all of the estimation period, the expected exchange rate change has been assumed to be aero. The foreign interest rate was proxied by the three- month U.S. Treasury bill rate. Various formulations of actual and expected inflation were also included in this equation to reflect the opportunity cost of holding money instead of real assets but were dropped because their estimated coefficent was found invariably to carry the wrong sign, to be statistically insignificant, or to lead to unstable simulations. This does not necessarily imply, of course, that this opportunity cost of holding money is irrelevant to the money demand function in Venezuela only that the mechanism for its measurement is more complicated.

2 Corrected for autocorrelation by the Cochrane-Orcutt transformation.

View Table

Table 3.

Estimated Model

item	Estimated Equation
Demand for real balances (equation (1))1	$\begin{array}{c}m=\underset{(-4.712)}{8.362}+\underset{(4.457)}{1.228}y+\underset{(2.894)}{0.154}f-\underset{(-1.701)}{0.011}{i}_f+\underset{(2.021)}{0.327}{m}_{t-1}\\ \begin{array}{cc}\begin{array}{c}{\overline{R}}^2=0.992\end{array}& \begin{array}{cc}H=0.335& SEE=0.045\end{array}\end{array}\end{array}$
Real private consumption (equation (2))	$\begin{array}{c}con=-\underset{(-2.784)}{0.632}+\underset{\left(4.866\right)}{0.229}y+\underset{\left(2.900\right)}{0.063}f-\underset{(-0.592)}{0.000001}EF{D}_{t-1}+\underset{\left(9.329\right)}{0.680}{con}_{t-1}\\ \begin{array}{cc}\begin{array}{c}{\overline{R}}^2=0.997\end{array}& \begin{array}{cc}H-1.183& SEE=0.019\end{array}\end{array}\end{array}$
Real private investment (equation (3))	$\begin{array}{c}KF/P=-\underset{(-2.101)}{16459.4+}\underset{\left(4.248\right)}{1.071}(Y/P)-\underset{(-2.493)}{0.01}(F/P)-\underset{(-1.349)}{0.159}{(K/P)}_{t-1}-\underset{(-2.666)}{1125.76}q\\ \begin{array}{cc}\begin{array}{cc}{\overline{R}}^2=0.924& DW=1.449\end{array}& SEE=1586.0\end{array}\end{array}$
Domestic inflation (equation (4))	$\begin{array}{c}\mathrm{\Delta }p=\underset{\left(5.403\right)}{0.115}+\underset{\left(3.385\right)}{0.265}\mathrm{\Delta }{y}^d\underset{(-7.243)}{-0.410}\mathrm{\Delta }k\underset{(-0.967)}{-0.000001}\mathrm{\Delta }EFD\underset{\left(0.803\right)}{+0.034}\mathrm{\Delta }{p}^t\\ \begin{array}{cc}\begin{array}{cc}{\overline{R}}^2=0.966& DW={2.140}^2\end{array}& SEE=0.019\end{array}\end{array}$
Growth of non-oil income (equation (5))	$\begin{array}{c}\mathrm{\Delta }y=\underset{(-2.052)}{+1.545}+\underset{(5.078)}{0.466}{y}^d+\underset{(0.882)}{0.017}(p^n-p^t)\underset{(-0.141)}{-0.000001}EF{D}_{t-1}-\underset{(-4.279)}{0.622}{y}_{t-1}\\ \begin{array}{cc}\begin{array}{cc}{\overline{R}}^2=0.795& DW=2.342\end{array}& SEE=0.02\end{array}\end{array}$
Imports (equation (8))	$\begin{array}{c}im=\underset{(-8.639)}{-5.585}+\underset{\left(1.510\right)}{0.316}e+\underset{\left(6.102\right)}{0.835}g\underset{\left(13.859\right)}{+0.878(}{p}^n-p^t)+\underset{\left(3.882\right)}{0.418}i{m}_{t-1}\\ \begin{array}{cc}\begin{array}{cc}{\overline{R}}^2=0.993& H=-0.562\end{array}& SEE=0.047\end{array}\end{array}$
Government domestic revenues (equation (10))	$\begin{array}{c}dr=\underset{(-8.007)}{-8.608}\underset{(16.980)}{+1.605}y\\ \begin{array}{cc}\begin{array}{cc}{\overline{R}}^2=0.954& DW={1.930}^2\end{array}& SEE=0.069\end{array}\end{array}$
Government expenditure (equation (11))	$\begin{array}{c}g=\underset{(4.499)}{0.304gr}\underset{(10.099)}{+0.698}{g}_{t-1}\\ \begin{array}{cc}\begin{array}{cc}{\overline{R}}^2=0.976& H=0.158\end{array}& SEE=0.068\end{array}\end{array}$
Private capital flows (equation (13))	$\begin{array}{c}PKI=-\underset{(-2.223)}{7121.360}+\underset{\left(3.073\right)}{1738.04(i}-i_f)+\underset{(2.333)}{0.157}\mathrm{\Delta }GDP+\underset{(2.500)}{0.009\mathrm{\Delta }}YUS-\underset{(-10.733)}{27070.8D}\\ \begin{array}{cc}\begin{array}{cc}{\overline{R}}^2=0.919& DW={2.073}^2\end{array}& SEE=2920\end{array}\end{array}$

Note: Figures in parentheses are t-ratios: R² is the adjusted coefficient of determination; DW is the Durbin-YVatson statistic H is the Durbin H-statistics and SEE is the standard error of the estimate.

¹The domestic interest fare was deleted from this equation because it did not prove to he significant and its inclusion did not improve the standard error of the equation. Moreover, since bclivares have been stable in relation to the U.S. dollar for almost all of the estimation period, the expected exchange rate change has been assumed to be aero. The foreign interest rate was proxied by the three- month U.S. Treasury bill rate. Various formulations of actual and expected inflation were also included in this equation to reflect the opportunity cost of holding money instead of real assets but were dropped because their estimated coefficent was found invariably to carry the wrong sign, to be statistically insignificant, or to lead to unstable simulations. This does not necessarily imply, of course, that this opportunity cost of holding money is irrelevant to the money demand function in Venezuela only that the mechanism for its measurement is more complicated.

2 Corrected for autocorrelation by the Cochrane-Orcutt transformation.