The following model postulates that the demand for money is a function of expected interest rate: Y_t = beta _0 + beta _1 X_t^* + u_t where Y = demand for money (real cash balances) X* = expected rate of interest u = error term. Since the expectational variable X* is not directly observable, we propose the following hypothesis about how expectations are formed: X_t^* - X_t - 1^* = gamma (X_t - X_t - 1^*) where 0