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Money, income and inflation in equilibrium - the case of Greece.

Article Excerpt
Abstract The specification of the linear long-run relationship among money, income and the opportunity cost of holding money has been a popular study in economic literature. In the specific case of Greece, numerous articles investigated this relationship using quarterly data, mainly of the period after 1960. The objective of this article is to investigate the same long-run relationship using annual data and covering the historical period between 1858 and 1938. The results of the used cointegration analysis are presented along with the findings of other authors who covered the post war era of the Greek Economy.

Keywords Equilibrium relationship * Cointegration analysis * Money market

JEL Classification C13 * C32 * C10 * E40

Introduction

The determination of the long-run equilibrium relationship among real money supply, real income, and the opportunity cost of holding money, nominal interest rate or inflation constitutes a popular application of many economic researchers' work.

In the case of Greek economy, the determination of a money demand function in either a cointegration or an error correction framework, was the core issue of the empirical work of Arestis (1988), Karfakis (1991), Psaradakis (1993), Papadopoulos and Zis (1997), Ericsson and Sharma (1996), Apergis (1999), Apergis et al. (1999), Karfakis and Sidiropoulos (2000), Brissimis et al. (2003) and Economidou and Oskooee (2005). These articles used mainly quarterly data covering a period of the Greek economy that extended after the end of the troublesome decade of 1940s. In this specific period of time, the national economy developed in the absence of major war or historical events, which could greatly affect the evolution of important macroeconomic magnitudes.

The aim of the analysis that is presented in this article is the determination of the long-run relationship among real money supply (M1), real Gross Domestic Product (GDP) and the opportunity cost of holding money using annual data and covering the period between 1858 and 1938. This period of time covers a great part of modern Greek history that is characterized by significant historical and economic events. In this specific period, the Greek economy performed its first steps in the global economic system after the war of independence (1821-1829). That is the reason, inflation was used as a proxy of the opportunity cost of holding money and M1 was selected as the most appropriate definition of money supply.

The following analysis is organized in three sections. The model and the methodology that will be used for the estimation of the long-run relationship among money, income and inflation are presented in the first section. The data provided by Kostelenos (1993) are used in the second section, in the context of which a cointegration analysis is performed. The results of this analysis are also exhibited and the findings concerning the magnitude of the cointegrating coefficients are compared with the empirical findings of other authors. The conclusions of the realized analysis are presented in the third and final section.

Theoretical and Methodological Issues

The scope of the analysis is to determine the long-run relationship among three macroeconomic magnitudes (real money supply, real GDP, and the opportunity cost of holding money) using annual Greek economic data and covering from 1858 to 1938. At this specific period of time, the operation of the Greek financial system was under the direct control of the monetary authorities, (1) and interest rates were administratively determined. Under these circumstances, the use of inflation, instead of interest rates, as a proxy of the opportunity cost of holding money is a common practice in applied macroeconomics (Karfakis and Sidiropoulos 2000, p. 84). As a result and given the absence of data concerning the nominal interest rates, inflation, the first difference of the natural logarithm of GDP deflator (1914 = 100) is used in the analysis as a proxy of the opportunity cost of holding money....