An econometric analysis of money demand function in Sudan, 1960 to 2010

Abstract

This study is an attempt to test the existence of a stable money demand function in Sudan during the period, 1960 to 2010. The money demand function includes real money balances, real GDP (as scale variable), the rate of inflation and exchange rate (as opportunity cost of holding money balances variables). The study applies cointegration and error correction models to examine the behavior of money demand during the period of analysis, all included variables have been expressed in logarithmic form (with the exception of inflation rate). Based on time series data (annually observations), cointegration results reveal that there is a long-run relationship between real money balances and the explanatory variables. In this long-run relationship, the estimated coefficients are consistent with the economic theory behind the demand for money. Error correction model (ECM) has been used to estimate the short-run money demand function, in which the estimated coefficients are also consistent with the economic theory and generally weaker in magnitude than those related to the long-run equilibrium. In this study, after incorporating the stability tests, the empirical results show that the money demand function is stable between 1960 and 2010. The study concludes that it is possible to use the narrow money aggregate as target of monetary policy in Sudan. Key words: Money demand, cointegration, error correction, stability, Sudan.