Abstract
This paper employs ECM approach to investigate the long run and short-run components of the broad money demand function in Mauritius for the period spanning from 2000 to 2009. To the author’s best knowledge, no study has been undertaken over broad money in Mauritius since 1992, with an update being long overdue. Results show that M2 is positively elastic with respect to GDP, with the elasticity coefficient revolving around 2.80%, clearly showing that Mauritius is not endowed with a fully developed financial system with monetization moving faster than output. The low adjustment coefficient for VECM furthers substantiates the fact that there is indeed a lack of alternative assets to M2 and above all fully justifies the transition from monetary targeting to interest rate targeting. Evidence is found in favor of foreign asset substitution but only through the exchange rate channel. Findings further show that the local stock market does not act as a substitute to local money holdings. Overall, the study points out a rather stable demand for money function in Mauritius so that the monetary authority can contemplate using it as a complementary tool but chiefly for long-run policy assessments.
Highlights
All central bankers agree that monetary transmission mechanism is complex to the effect that some simple rules of thumb are considered as vital elements in fine-tuning or crosschecking their decisions
The VECM model has been run but the exogeneity tests show that LIBORUSD and SEMR should be treated as exogenous variables
The results show that, though, the demand for broad money in Mauritius is positively elastic with respect to GDP, yet, it is greater than two with an elasticity of 2.80 per cent, clearly depicting that the level of monetization is high in Mauritius
Summary
All central bankers agree that monetary transmission mechanism is complex to the effect that some simple rules of thumb are considered as vital elements in fine-tuning or crosschecking their decisions. In that respect, following the widely agreed fact that inflation is always a monetary phenomenon, it becomes sensible to consider the money demand function with a view of ending up with an enhanced monetary policy decision process It is with this motive in mind that the current research proceeds towards analyzing the money demand function in Mauritius. Bearing in mind these fundamental changes, an update for the broad money demand function in Mauritius is long overdue Another motive for analyzing the money demand function in Mauritius follows from the recent study of Tsangarides (2010) who finds that the current monetary policy tool generates a rather weak transmission mechanism with the policy interest rate having a weak impact on output.
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