This paper explores the role of financial innovation in the demand for money and which of eight scale variables is appropriate for the demand for money. The empirical results of this paper suggest that financial innovation is very important in determining the demand for money. The results also indicate that a good general proxy for financial innovation is either a stochastic trend or a combination of a stochastic trend and a deterministic trend, rather than a deterministic trend alone. The estimated path of financial innovation also shows that inclusion of a deterministic trend makes the path more fluctuant and the range of the time-varying intercept smaller.;The results for the in-sample performance show that private spending in M1 and final sales in M2 produce the smallest standard error of the estimate in all three specifications. According to the value for the consumption weight, consumer expenditure generates more money demand than GNP, GDP, disposable income, domestic absorption, and final sales. The new scale variable which is a weighted average of consumer spending on durables, nondurables, and services, is a better scale variable than consumer expenditure. The result implies that consumer spending on durables generates more money demand than consumer spending on nondurables and services. Therefore, it can be concluded that consumption is a better scale variable than income.
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