Abstract
The objective of this study was to analyze the money demand function for Zambia for the period 1978 – 2018 using annual time series data. The study employed the Gregory Hansen cointegration technique. The study also employed Hendry’s General to Specific technique to estimate the error correction model by obtaining a parsimonious model. The results of the Gregory Hansen test confirmed the presence of a cointegrating relationship and selected the GH-2 model as the most plausible model with a level shift and a trend. The results also endogenously determined 1994 as the break year in the money demand function. Other interesting results obtained by the study suggest that inflation and interest rate are the robust determinants of real money demand both in the short and long run. Furthermore, unlike many other developing countries, the results show that money is a necessity in Zambia. The other interesting results suggested by the study are that the financial sector reforms of 1994 diminished the demand for real money; however, the positive time trend suggests that there has been an increase in real money holdings over time in Zambia. The low-interest elasticity of money demand also potentially compromises the effectiveness of money supply as a monetary policy tool for economic stabilization. The results of the CUSUM and CUSUMSQ confirm the stability of the money demand function in Zambia.
Highlights
Monetary policies have been widely used by many developed and developing countries to achieve low levels of inflation and to stimulate economic growth
13 Towards the end of 1993, interest rates where decontrolled, exchange rates where liberalized in 1994 following the cessation of the Exchange Control Act in 1994. Another notable event was the introduction of the Treasury bill tender system, the establishment of the Lusaka Stock Exchange (LuSE) in February 1994 and the strengthening of the financial sector by the enactment of the Banking and Financial Services Act in December 1994
A stable money demand function is an important ingredient for the formulation of sound monetary policy and economic growth
Summary
Monetary policies have been widely used by many developed and developing countries to achieve low levels of inflation and to stimulate economic growth. A sound comprehension of the stability and determinants of the money demand function is key in the implementation of monetary policy. This enables the Central Bank to implementation of policy-driven changes in monetary aggregates to influences macroeconomic variables 1 (Subraram, 1999; Nachega, 2011; Halicioglu & Ugur, 2005). Starting from the deregulation policies of the 1980s, where industrial and labor policies in most developed countries moved from direct government intervention policies to market forces and competition. Market-based monetary policy instruments were not plausible. This was due to the perceived underdeveloped financial markets and the control of interest rates. Many developing countries later started adopting similar structural changes
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