Fiscal policy, monetary targets, and the price level in a centrally planned economy : an application to the case of China

DRAFT FOR STAFF USE ONLY FISCAL POLICY, MONETAnY TARGETS, AND THE PRICE LEVEL IN A CENTRALLY PLANNED ECONOMY; AN APPLICATION TO THE CASE OF CHINA Andrew Feltenstein and Ziba Farhadian (IMF) CPD Discussion Paper No. 1985-32 August 1985 CPD Discussion Papers report on work in progress and are circulated for Bank staff use to stimulate discussion and comment. The views and interpretations are those of the authors. ABSTRACT Fiscal Policy, Monetary Targets, and the Price Level in a Centrally Planned Economy; an Application to the Case of China by Andrew Feltenstein and Ziba Farhadian* Th.s paper applies a monetary model of a planned economy to China. A supply equation derives the change in broad money corresponding to government transactions at official prices. There is an unobserved true price index that determines consumers' demands for money. Consumer demands for real cash balances, as well as the divergence between the official and true price indices are derived. The model is estimated and it is found that changes in the money supply are explained by government transactions, while real money balances are explained by real income and the anticipated true rate of inflation. The true rate of inflation is 2.5 times the official rate. *Senior Economist, Country Policy Department, World Bank, and Research Assistant, Fiscal Affairs Department, International Monetary Fund. Fiscal Policy, Monetary Targets, and the Price Level in a Centrally Planned Economy; an Application to the Case of China Andrew Feltenstein and Ziba Farhadian* I. Introduction In virtually all economies, whether centrally planned or market- oriented, a key task for government policymakers is to determine suitable targets for the macroeconomic variables under their control. In this paper we will demonstrate how, in the case of China, the use of official price indices, combined with certain standard estimation procedures, can cause these targets to be seriously misspecified. In developing a technique for correctly determining price level, money supply, and government budget deficit in a planned economy of this type, we shall also obtain an estimate of the degree to which repressed inflation has existed in China during the time period of our study, 1954-81. Typical models of market economies may specify a government budget deficit that is exogenous, either in real or nominal terms. Other models may state that real government expenditures are exogenously determined, while the price level, the nominal value of taxes, and *Senior Economist, Country Policy Department, World Bank, and Research Assistant, Fiscal Affairs Department, International Monetary Fund. The views expressed in this article are those of the authors and not neces- sarily of either institution. We would particul-rly like to express our thanks to Etisham Ahmad, Mohsin Khan, and Nicholas Stern for their suggestions that contributed to this paper. Lars Bergman, Luc de Wulf, Morris Goldstein, Vito Tanzi, and an arnonymous referee have also made helpful comments. An earlier version of this paper was written while the first author was visiting the Stockholm School of Economics. -2- hence the nominal value of the government deficit, are endogenous. Aghevli and Khan (1978), Tanzi (1978), and Clements (1980) present models of the first type, while a model of the second type is cons- tructed in Feltenstein (1984). Changes in the money supply are related to the size of the government budget defict but also depend upon the external economy. If the economy is completely open, then increases in the stock of money, beyond that which people are willing to hold, may leave the economy either through increases in imports or through capital outflows. If the economy is less than fully open, increckses in the money supply may be translated into increases in prices, as well as losses in foreign reserves. Many empirical studies have been made of this approach, an example being The Monetary Approach to the Balance of Payments (1977). In a market economy, the government will try to estimate the behavioral connections between the policy instruments under its control, such as the size of the budget deficit, and the endogenous variables that they affect, such as prices and the balance of payments. In a centrally planned economy, however, government controls can cause a number of distortions in behavior patterns. Many, if not all, prices are centrally determined and therefore do not, at least immediately, reflect the macroeconomic disturbances that would show up in market- determined prices. 1/ Because there are controls on both imports and the capital account, the external sector does not automatically act as a balancing agent, as it does in an open economy, although central planners do use foreign trade in a crude way to balance the plan at a -3- macro level. Studies made of economies that are partially market-oriented and partially centrally planned tend to indicate that the impact of the government's actions on the market sector increases according to the degree of centralization of the economy, since the market sector must bear the full brunt of any adjustment made by the government. A general discussion of so called "repressed" economies is given in McKinnon (1973), while the specific example of Ethiopia has been studied in Feltenstein (_ 85). Another type of situation occurs in an economy with complete controls in which, for example, a rapid increase in the money supply leads to parallel markets whose prices reflect the consumer's increased nominal buying power. The question then arises of whether government policies that cause changes in the money supply can matter in an economy where controls are strictly enforced. Suppose, for example, that in an economy with rigid price and capital controls, a large government deficit leads to a correspondingly large increase in the money supply. At the same time, however, suppose that there is no increase in real output. The study of resulting outlet for such excess monetary creation has been the subject of a body of literature on disequilibrium models for centrally planned economies (see, for example, Clower (1965), Barro and Grossman (1971, 1974), Howard (1976), and Charemza and Gronicki (1984 a). The aim of this paper is to construct a very simple model repre- senting such a situation. The model is applied to China where, over the past several years, the money supply has grown considerably more quickly than real income. The increase in money has, however, largely -4- been reflected in increased savings and time deposits, thereby relieving the pressure on prices. 2/ Because it is unlikely that this rapid increase in savings can continue indefinitely, it is important for the government to be able to measure accurately the impact of its own actions on the money supply, so that it is not continuously required to use savings deposits as a balancing tool. In the situation just described, savings have increased because of shortages in available consumer goods. Because the official price index is rising less rapidly than the money supply, however, real cash balances held by the public (measured by household money hoMiings and valued at the official price index) are also rising. The question then arises as to what rate of inflation would induce people to hold the increased nominal money stock, if there were no price controls and the availability of consumer goods remained limited, as discussed in Portes (1977), and Portes and Winter (1980). 3/ Applying a neoclassical description of consumers' attitudes toward money in the Chinese economy could be somewhat controversial. A lengthy justification for using such methodology in this context is given in Peebles (1983), which also presents a useful description of the Chinese monetary system. The possibility of excessive monetary expansion influencing prices is also recognized by Chinese sources: If social purchasing power much exceeds commodity supplies, then part of the purchasing power will not be realized and will become excess currency circulation on the market which will influence the stability of the market and currency. Of course, if it is the purchasing power of the urban and rural population that is not realized then currency will accumulate in their hands, or in the form of savings deposits. 4/ -5- We do not claim that the Chinese monetary system operates in a neoclas- sical manner, but rather that the empirical techniques described in the next section can help identify and estimate certain underlying pressures associated with governmental fiscal policies. The next section contains a simple model designed to estimate certain behavioral characteristics of the Chinese monetary system, and, in particular, to simulate the impact on money and prices of various government fiscal instruments. The model, particularly on the side of the money supply equation, contains certain features which apply partic- ularly to China. The third section will present the results of estima- tions using Chinese data, while the fourth section will present a simple simulation example. The final section will be a summary and conclusion. II. The Model The model consists of two basic equations: the first describes changes in the money supply; the second is a behavioral equation des- cribing consumer demand for real cash balances. The money supply equa- tion is straightforward and shows that changes in the nominal quantity of broad money are explained by four variables. LM2 = ao + al (D-F-AWB) + a2 CA + a3 F + a4 AWB (1) where: M2 = the stock of broad money; D = the budget deficit of the central government) minus foreign borrowing and domestic bond sales; 51 CA = the current account expressed in domestic currency; AWB = the total wage bill of the government and state enterprises; -6- F = procurement payments made by the government to the rural sector for agricultural purchases; A = change in a variable expressed as a first difference. Equation (1) is partly an accounting identity and partly a behav- ioral equation that is specific to China. The equation postulates that increases in the money supply pay for, at least partially, increases in the total wage bill of the public sector (AWB) as well as in the level of procurement payments to the rural sector (F). 6/ These terms are subtracted from the money-financed portion of the government deficit in order to avoid double counting. Ideally, changes in foreign reserves should have been used as the final explanatory variable in equation (1). Data on the overall balance of payments are, however, not available for the period over which these estimates are made. Instead, the domestic currency value of the current account has been used. According to Peebles (1983, p. 87), "The main item of currency issue is wages, bonuses, and other labor remuneration . . . . The second element is for the purchase of agricultural and subsidiary products, and the third is credit extended to the rural population . . . . The fourth channel is for the sundry expenses of enterprises and units." We should make certain qualifications concerning the reasoning underlying equation (1). The Chinese series for broad money reflects money held by households, and does not, for example, contain money held by state enterprises. One would expect that procurement payments to farmers and wage payments to public sector workers would have a direct impact on household money balances. The impact of other items of -7- government spending on household money balances is less clear. The significance of the coefficient of these terms in the estimated version of equation (1) perhaps reflects the possibility that, over the extended time period of our study, household money balances have moved broadly in line with overall cash balances. It should also be noted that the Chinese definition of broad money is in terms of the net amount that remains after retail sales have caused money to be withdrawn from the gross amount injected by wage payments, agricultural pr.curement payments, and other credit items. 7/ Variables AWB and F, entering equation (1) as independent variables, reflect the behavioral nature of the equation and explain the formation of the money supply. In effect, the equation suggests that the government sets the targets for these two variables, and corresponding increases in the money supply are made, independent of their connection with the overall government budget deficit. Thus, the government could realize a budgetary surplus yet still carry out an expansionary monetary policy. One would, of course, expect that the estimated coefficients in equa- tion (1) have positive signs. The representation of consumer demand for real cash balances is somewhat more complex. Possibly the most important problem in estimat- ing the demand for real money balances in a planned economy comes from the fact that official prices do not necessarily reflect the implicit prices that consumers actually face. Such prices, while not necessarily observable, may, for example, reflect the presence of scarcities or -8- black markets. There is an extensive literature on black markets, or underground economies. See Tanzi (1982) for a number of articles on the subject.' The problems of estimating corresponding excess demands are discussed in Portes and Winter (1977, 1980). Charemza and Gronicki (1984 b) arrive at quite different conclusions, however, in a model of Poland that is based upon slightly different assumptions about excess demand formation. 8/ A study of an earlier period in Chinese history is given in Jao (1967-68). Although there are no observable black markets in China, there is, however, evidence of shortages in certain consumer goods markets. 9/ It is assumed that there is some rate of inflation which would cause consumers, in the absence of commodity shortages, to hold the same quantity of money as they are observed to hold at the existing official prices and existing shortages. Consumers are assumed to behave "as if" there were some rate of infla- tion different from the official rate. If this observation can be proven, it would allow macroeconomic forecasts to be made even without the knowledge of individual market shortages, assuming that some stable relationship exists between this implied inflation rate and the official rate. The representation of the demand for money function that is developed is based on the Cagan (1956) specification, while the form we use is described in Khan (1980). 10/ The demand for real cash balances, md, is assumed to be given by md - a0 + &1 log y + a27T (2) Here, md = (M2 /pT )d, where M2 is the nominal supply of broad money and PT is the true price index, which is unobservable, though effectively perceived by the consumer in terms of his consumption behavior. In addition, y denotes the real income of the economy, and TE the expected rate of inflation in the true price index. Also, RT, the unobserved true rate of inflation, is given by T = log PT - log PT-1 3) Since the level of real income in China is measured directly, rather than by using price deflators, real income has not been modified by the true price level, PT. It is assumed that there is a connection between the true and official price indices given by log PT = log P, (4) where P is the official price index as reported by the government and a > 0. There is no way to know a priori whether this is a reasonable specification. The estimation results reported in Section III suggest, however, that it is indeed reasonable and that the coefficient a may be treated as a constant. 11/ It will also be assumed that ifE the T expected rate of inflation in the implicit price index, is given by an adaptive expectations scheme depending, in turn, upon the historical series of true rates of inflation. Thus 7TE a =(-1 T (E1) 0 < S < 1 (5) - 10 - where the subscript (-i) denotes the lagged value of the corresponding variables. Thus, the anticipated true rate of inflation adjusts proportionally to the error made in predicting the previous rate of inflation. In addition, it is assumed that the real stock of money, valued at the true price index, adjusts proportionally to the difference between the demand for real money in the current period and the actual stock in the previous period. Hence Alog m = X(log md - log m-1), 0 < A < 1 (6) and where m = M2/PT This is not to say that the Chinese monetary authorities actually follow such a rule in adjusting the stock of money, rather that changes in the money supply have tended to behave in such a way. Combining equations (2)-(6) and setting M M2 for simplicity of notation, 12/ log m - a log P - (1- ) log M-1 + (1-6) a log P-1 (7) = Xa0 + al X(log y - (1-8) log y-1) + Aa2 aaw + (1-)(log M-1 - a log P-1 - (1-)log M-2 + (1-a) a log P-2) The interested reader may see Khan (1980) for an example of how this type of derivation is carried out. The above expression may be then simplified by redefining variables in the following way: m = b0 + bly + b2l + b3m-1 (8) where: m E log M - a log P - (1-B) log M-1 + (1-8) a log P-1 y E log y - (1-0) log y-1 nT aa - 11 - An expression has thus been derived representing the original money demand equation, but in which all unobserved variables, namely those represented by the true price index, have been replaced by observed variables, viz., the official price indices. The equation is underidentified in this form, however. As a result, a priori values, arising out of a constrained search procedure, based on a log-likelihood function, will have to be given to a and a to identify the equation. III. Equation Estimates In this section, parameter estimates of equations (1) and (2) using Chinese data are presented. The sources for data used in these estimates are Chinese Statistical Yearbook (1983); International Financial Statistics, various issues; and Byrd (1983). Equation (1) was estimated using annual data over the period 1954-81. Ordinary least squares were used with the following results: 2= -3.90 + 0.427 (D-F-AWB) + 0.005 CA + 0.672 F + 0.323 AWB (-3.62) (4.10) (0.01) (4.64) (2.33) R2 0.83 D.W. = 2.00 (9) The numbers in parenthesis denote t-statistics. Changes in broad money are thus reasonably well explained, and the coefficients of the explanatory variables are, with the exception of the current account, all significant at the 5 percent level. The obvious reason for the lack of explanatory power of the current account variable in equation (9) is that the overall balance of payments (the change in foreign reserves) would have been a more appropriate variable. As mentioned earlier, the - 12 - necessary data are, however, not available. The difference between the estimated coefficients reflects the behavioral characteristic of the money supply equation. Thus, for example, a higher proportion of pay- ments for farm procurements appear to be monetized than are public sector wage payments. Finally, all coefficients have the correct sign and have plausible magnitudes. 13/ One may now turn to the estimation of equation (2). As mentioned at the end of Section II, it is necessary to carry out a simultaneous search over values of the parameter a connecting the official to the true rate of inflation, and the parameter B, representing the speed of adjustment of inflationary expectations. By doing so, one can identify individual parameters in an equation which is nonlinear in its parameters. Dhrymes (1971) contains a description of search methods for under-identified equations. 14/ The criterion for choosing a value for - and B is the log-likelihood function, since for each value of 0 and a, the equation can be estimated by ordinary least squares. Bounds can be placed on the values of these parameters, however, as we would expect that 0 < B < 1, and a > 0. The parameter a is allowed to vary with increments of 0.05 over the range 0-1, and for each value of 0, we changed a between 0-4 (also with increments of 0.05). The values of a and B that maximized the log-likelihood function of the estimated parameters of equation (8) were a = 2.5 and S 0.45, with the following results: - 13 - m = -0.408 + 0.350 y - 1.026 i + 0.745 m- .(-2.15) (2.35) (-1.78) (5.19) R2 = 0.91 D.W. = 1.87 (10) All coefficients in equation (10) have the correct sign and, with the exception of the expected inflation variable, n, are significant at the 5 percent level. 15/ The goodness-of-fit and Durbin-Watson statistic are also satisfactory. The value for a indicates, by equation (4), that the true rate of inflation is 2.5 times higher than the official rate, i.e., n = 2.5 n (11) The parameter a = 0.45 indicates that the rate of adjustment of infla- tionary expectations to changes in the historical series of inflation is relatively slow, as might be expected in a country with fairly stable price indices. The original parameters from equations (2) and (6) may now be identified and are: a0 = -1.60, a1 = 1.373, a2 = -4.023, X = 0.255 (12) Thus, the income elasticity of real money balances is 1.373. It is interesting to compare this result with that generated in other studies of the demand for money in economies with price controls. In Feltenstein (1985), for example, where a similar equation was esti- mated for the Ethiopian economy, the corresponding income elasticity was found to be 5.7. Similar results (i.e., income elasticities higher than 2.5) have been found in other planned economies with price controls. The key difference between these estimates and those in the model comes - 14 - from the use of the parameter a, connecting official and true rates of inflation. This parameter indicates that inflation, as perceived by the public in its attitude toward holding money, should actually have a greater weight in explaining demand for money than would be the case if the official price index were used. Accordingly, studies that use the official price index tend to place too much weight on the real income variable. The usual explanation for these high coefficients is the increasing monetization of the economy. It seems, however, quite unlikely that such rapidly increasing monetization could continue for the length of the sample's time period. It is also interesting that the estimate of the income elasticity of real cash balances is broadly in line with estimates for economies without price controls. A problem with our equation estimates could arise if it were determined that the parameters were not stable over the time period in question. Such a situation might occur because of the many policy changes that have taken place inChina over the past 30 years. Accord- ingly, we have carried out the test of stability described in Brown, Durbin, and Evans (1975), which has been applied in Heller and Khan (1979). We have implemented the cusum test, as described in Brown, et al. If the value of the cusums is greater than the critical value at a particular significance level, then the null hypothesis that the parameters of the model are constant is rejected at that significance level (see Heller and Khan (1979) for a more detailed explanation). Using forward recursivd regressions for both money demand and supply equations, equation (8), money demand, has a cusum value of 0.55, - 15 - while equation (1), money supply, has a cusum of 0.74. The critical value at the 10 percent level is 0.85. We may thus assume that both equations are stable over the time period. It may be useful to report the results of a similar regression where, instead of using the methodology described above, official data combined with a partial adjustment, adaptive expectations pattern is used. The following estimation results emerge: m = -0.639 + 0.465 y + 0.955 7r + 0.645 m-1 (-2.82) (2.89) (0.83) (4.28) = 0.6 R2 = 0.95 D.W. = 1.67 (13) Here the variables are defined by: m = log M/P - (1-)1og (M/P)-1 y = log y - (1-a)log y-1 Thus, equation (13) represents the estimates resulting from the standard methodology for estimating a demand for money function using adaptive expectations. When the underlying parameters from equations (2), (5), and (6) are identified--equations (3) and (4) are not used here--the following coefficient estimates result: 00 = -1.80, al = 1.31, a2 = 2.69, A = 0.355 (14) It is immediately clear that the apparently good fit of equation (13) is a spurious correlation. The coefficient of expected inflation a2 is positive so that a 1.0 percent increase in anticipated inflation would - 16 - lead to the public's increasing its holding of real cash balances by 2.69 percent. 16/ Clearly this result is unacceptable, since it requires the public to increase the real value of its money holdings simultaneous with the decline of that money's purchasing power. In particular, if equation (13) were used to estimate the impact of changes in government- controlled price and monetary variables on public attitudes toward holding money, it would lead to predictions in exactly the wrong direc- tion. Thus, the method used in this paper for deriving a true rate of inflation leads to a significant qualitative improvement in estimating the demand for money function. IV. A Simulation Example Let us suppose that the government wishes to estimate the monetary effect of changes in the parameters under its control. Let us suppose also that the government, in setting its monetary targets by using equation (9), wishes to do so in such a way as to confirm the public's predicted demands for real money balances in the forthcoming year. In order to give our data the proper order of magnitude, we will suppose that information for 1980 is known, and that it is desired to set targets for 1981. Let us take the target for inflation to be the actual rate of growth i.n the consumer price index for 1981, i.e., I = 2.6 percent. Let us also suppose that the target rate of real growth is 6.0 percent. Based on the past series of historical data, we may then solve equation (10) to obtain: - 17 - M2 = 152.9 billion yuan, LM2 = 8.9 billion yuan (15) Thus, the planners would have a targeted expansion for 1981 of 8.9 billion yuan, or 6.2 percent of the 1980 supply of broad money (144.0 billion yuan) if they wished to conform to the public's historical behavior toward money holdings, corresponding to the inflation and real output targets they have set. Suppose, again as a purely hypothetical example, that the planners set a target of 2.5 billion yuan for the government deficit, D, and a target of equilibrium in the current account, i.e., CA = 0. Incor- porating these numbers, as well as the results of equation (15), in equation (9), we obtain: 52.24 + 0.42 AWB = F (16) Thus, for example, if it were desired to set AWB = 30.C billion yuan, then a target of F = 64.84 billion yuan should be set for procurement payments to farmers in order to remain consistent with the monetary expansion target, as well as the historical behavior of the money supply equation. It is, of course, perfectly possible for government planners to use equation (9) to set monetary targets that do not conform to the public's anticipated demands, given the rate of inflation set for the official price index. The result of such a policy would be that the public would increase its real cash holdings. Such a phenomenon has actually occurred in China since 1978, and is reflected in the rapid growth of savings deposits. Indeed, prior to 1979, an accommodating - 18 - credit policy interacted with the system of central planning, as practiced at the time, to generate excess liquidity. This excess was checked through rationing and administrative controls. Since 1978, however, new macroeconomic policies have been developed that rely less on direct controls. In particular, enterprise managers have increased autonomy in setting their own levels of investment. The rapid, and unexpected, increase in savings, due to monetary targets not in line with the public's demands, has led to the easy availability of funds for investment. Accordingly, there has been an increase in the rate of capital formation far beyond the levels envisaged in the annual plans, while there have simultaneously been shortfalls in the outputs of consumer goods. V. Conclusion This paper constructs a monetary model of a centrally planned economy with price controls. The first part of the model, a money supply equation, derives the change in the money supply corresponding to exogenous fiscal and trade parameters for which the planners set targets. Since the government carries out its transactions at official prices, this monetary target reflects the target rate of inflation. In the second part of the model, the assumption is that there is an implicit, or true, price level, reflecting shortages and certain other factors, that determines consumer demand for money. An equation is derived that simultaneously estimates consumer demand for cash balances, as well as the divergence between the official and true price indices. - 19 - For China, the money supply and real balance demand equations were estimated using historical data. Changes in the money supply were found to be explained by the government deficit, the wage bill of the government and state enterprises, and procurement payments to farmers. Real money balances were found to be explained by real income and the anticipated true rate of inflation, and the true rate of inflation was determined to be approximately 2.5 times the official rate. A simulation was carried out to indicate the way in which the estimated model could be used to either determine market clearing prices, or to approximate the level of monetary disequilibrium that would be caused by a particular target for official prices. - 20 - Footnotes 1/ There are, however, other indicators of these disturbances, such as savings accumulation, inventory changes, black market, or second economy price levels. 2/ This increase in savings that occurred is as most of the models mentioned in the previous paragraph would predict. 3/ The official price index in China is a consumer price index that comprises a retail price index for state-owned enterprises, with a weight of 90 percent, and a service sector price index, with a weight of 10 percent. The estimation results of Section III will indicate that it is incorrect to use the official price index as a deflator, since it tends to understate the underlying rate of inflation. 4/ Liu (1980), p. 169, quoted in Peebles (1983), p. 86. 5/ Thus, D reflects that portion of the government deficit to be financed by monetary expansion. 6/ The government acts as a purchasing agent by buying goods from farmers and selling them in urban centers. 71 In most centrally planned economies there is a distinction made between enterprise deposits and household cash, with enterprise deposits not being readily convertible in cash and vice versa. Presumably, monetary and fiscal policy would affect the enterprise sector first and then spread gradually to the market for household cash as, for example, household wages were bid up. Thus, it would have been incorrect to - 21 - estimate a money demand equation when the money supply series contained both enterprise deposits as well as household cash holdings. Fortunately, the Chinese money supply series contains only household deposits, so we are able to avoid this problem. 8/ Unlike the models developed in these papers, the authors do not assume that trading actually takes place at black market prices. 9/ There is much impressionistic discussion of this problem (as an illustration see Delfs (1982)). 10/ The reader interested in the use of this type of specification to a much earlier period in Chinese history, the Southern Sung dynasty (1127-1298 A.D.), may wish to see Liu (1983). 11/ It might be claimed that equation (4) should contain a constant term, i.e., log PT = bo + bl log P. As will become clear, this would lead to an underidentification problem in the estimated form of the equation. 12/ Recall that, as in equation (2), y--real income-is not deflated by PT, since the original estimates for Chinese national income are price independent. 13/ Although it is possible that there may be multicollinearity between the estimated coefficients in equation (9), this would not be relevant for the purpose of this study, since the interest is in the power of the entire equation in explaining changes in household money, rather than in the impact of any one of the exogenous parameters. - 22 - 14/ The values of a and B that maximize the log-likelihood function have asymptotic maximum-likelihood properties. 15/ The coefficient of expected inflation falls just short of being statistically significant, although its sign is correct and its order of magnitude is plausible. It is interesting to note that the coefficient of the real income variable is significant, although in many such short- run money demand equation estimates for other developing countries, the corresponding coefficient fails to be significant. We shbuld note that the use of national income as an explanatory variable is not strictly correct. Ideally we should use household consumption; such figures are not, however, available. 16/ The coefficient of inflation is not significant, but the goodness-of-fit of equation (13) would cause its point estimate to nonetheless be used as an explanatory parameter, thus reflecting its positive sign. - 23 - References Aghev1i, Bijan B., and Mohsin Khan, "Government Deficits and the Infla- tionary Process in Developing Countries," Staff Papers, International Monetary Fund (Washington), Vol. 25 (September 1978), pp. 383-416. Barro, Robert J. and Herschel I. 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