This paper investigates the long-run equilibrium relationship among money, income, and interest rates in Korea. Particularly, the relationship is investigated under the classical money demand framework. In order to tackle this theme effectively, this paper relied on the Johansen and Juselius’s multivariate cointegration method. The model was designed to reflect the impact of 1997 financial crisis by using the sample spanning from 1980 to 2003. This paper is distinct from prior studies in making comprehensive statistical tests on both the significance of elasticities associated with a structural money demand function and the parameter constancy in the cointegrating space.
The major findings can be summarized as follows. First, there is one cointegration vector among real money, real income, and interest rates. Or there are two common stochastic trends. Second, the estimated cointegrating equation can be considered a stable long-run money demand function. It turned out that coefficient estimates were consistent with the classical money demand theory. The unitary income elasticity hypothesis was sustained, which is consistent with the argument of Milton Friedman. The interest rate elasticity of money demand was estimated -0.09. Third, the recursive analysis lent support to the argument that the broad money demand in Korea is stable, which is in contrast to the previous empirical study.
