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Kajal Lahiri, Professor of Economics at SUNY-Albany, was a Visiting Scholar in the Research Department when this paper was written. The authors are grateful to Mohsin Khan for helpful comments, and to Ravina Malkani for excellent research assistance.
It might be noted that few studies have found reliable or significant estimates of interest elasticities of consumption in developing countries. See for example Rossi (1988).
Note that the Mundell-Fleming structure of this model implies that exports and domestic output are perfect substitutes.
Once again, empirical applications of this specification are extensively discussed in Goldstein and Khan (1985).
We used the approximation:
In our estimation the first order term was found to be adequate.
The additional lagged term in Y permits the demand for money to adjust more slowly in response to changes in income than to changes in interest rates.
The countries in the sample are: Brazil, Chile, Colombia, Costa Rica, Ecuador, Egypt, Ethiopia, Greece, Guatemala, India, Indonesia, Jamaica, Jordan, Kenya, Korea, Malawi, Malaysia, Malta, Mexico, Morocco, Nigeria, Paraguay, Philippines, South Africa, Sri Lanka, Tanzania, Thailand, Tunisia, Turkey, Venezuela, and Zambia.
For more detailed discussion of estimation with variance components see Belestra and Nerlove (1966), Hausman and Taylor (1981), Amemiya and McCurdy (1986), Breusch, Mizon and Schmidt (1989), and Maddala (1987).
Note that a within-country transformation of a variable Yit (i = 1, 2, .., N; t = 1, 2, .., T) is simply
The term “between-country data” refers to the country-specific means
All equations are estimated in per capita terms in order to avoid heteroskedasticity in errors due to the widely varying sizes of the countries in our same.
λj is the variable that is used to transform the data [i.e.,
Note that our model formulation allows all the endogenous variables to be correlated with ηji and εjit in all equations. However, the exogenous variables are assumed to be uncorrelated with ηji and εjit. Some of the exogenous variables, however, can be correlated with ηjit, but uncorrelated with εjit. Cornwell, Schmidt and Wyhowski (1988) refer to this latter group as “singly” exogenous variables. For consistent estimation, the country means of the “singly” exogenous variables
Since aggregate employment data are seldom available for developing countries, we used the population as a proxy for L.
Estimates of income elasticities of money demand substantially above unity are quite common in developing countries. See Khan (1980).
In view of this result we re-estimated the model, imposing perfect capital mobility to see if the coefficients were altered in any significant manner. The results are essentially unchanged, with the exception of the consumption function. This function exhibited substantially greater interest-rate elasticity. The estimated fraction of liquidity-constrained households was about a third, a result which is much closer to the estimates in Haque and Montiel (1989).