An error correction approach to modelling money balances and reserves

The objective of this study is to propose an economic model of the nominal money balances and reserves in the Turkish economy during the period 1960‐1988. As most of the variables show unit root non‐stationarity, an approach based on the error correction system (Phillips, 1991) is adopted. The estimated parameters of the long‐run money balance relationship based on this error correction system are very close to the Johansen‐Juselius (1990) vector autoregressive modelling approach. An error correction system and the vector autoregressive modelling approaches are alternative representations of the cointegrated systems. This study empirically demonstrates the closeness of the two systems using the data from the Turkish monetary sector. The econometric estimates of the elasticities are plausible. In small samples, both approaches may not yield almost identical estimates since the theory underlying these approaches is asymptotic.