Evidence on nonlinear error correction in money demand: the case of Taiwan

This paper proposes a nonlinear error-correction model based upon smooth transi-tion regression methodology. The model is speci ® ed such that the short-run adjust-ment toward long-run equilibrium is nonlinear and that the error correction is a smooth function of long-run deviation. Empirical results obtained from estimating M2 money demand in Taiwan support the hypothesis of a nonlinear error-correction process and provide better interpretation of change in the demand for money. The role of the money demand function as a cornerstone of economic policy has been challenged since the mid-1970s. The traditional approach to the demand for money, from the quantity theory to the Baumol ± Tobin model to th