Abstract
The paper examines demand for real money balances in six West Africa countries, over the 1985-2014 periods using panel Cointegration technique. The result shows that long run money demand is positively related to real income, inflation rate and inversely related to interest rate spread, real effective exchange rate and US real interest rate. Long run income elasticity is greater than unity and less than unity in short run. All variables are significant except effective exchange rate, thus; both currency substitution and capital mobility hypotheses hold in the long run while capital mobility holds only in the short run. We recommend that monetary aggregate should growth slower than economic growth to maintain price stability, countries should try to maintained stable exchange rate and ensured market driven interest rate policy. Keyword: Demand for Money; Interest Rate Spread; Capital Mobility and Currency Substitution, Panel Analysis.JEL CODE: E41, E52, C33, O11.
Highlights
Monetary integration and adoption of indirect monetary policy instruments in economic management have brought a new paradigm shift in the formulation and implementation of monetary policy in West African countries, especially among West African Monetary Zone (WAMZ) member countries
The formulation of effective and efficient money demand functions cannot be overemphasized in the design and implementation of monetary policy in developed and developing economies alike
+ δ3∆ln(Pi)t + δ4ln(REERi)t + δ5RUS,t + εit where i denotes a specific country and varies from 1 to 6; t is time, with the time series spanning from 1980 to 2014; M 2 is the stock of broad money; P is the GDP deflator; Y is the real GDP as a proxy for transactions and precautionary demand for money; RD is the time deposit interest rate; RL is the lending interest rate; RUS is the U.S real interest rate; and REER is the real effective exchange rate
Summary
Monetary integration and adoption of indirect monetary policy instruments in economic management have brought a new paradigm shift in the formulation and implementation of monetary policy in West African countries, especially among West African Monetary Zone (WAMZ) member countries. It is believed that the relationship between money supply and income, prices, and balance of payments is determined by demand for money This relationship plays an important role in macroeconomic issues such as economic growth, price stability, unemployment, and the balance of payments in any nation. The efficacy of monetary policy regimes depends on the strength of monetary transmission mechanisms and the velocity of money in an economy When these relationships are subject to unintended shifts, monetary targets lose their transparency and are less able to accurately provide signals for the appropriate stance of monetary policy. This paper employs interest rate spread to examine the effect of interest rate on demand for money in the WAMZ countries, albeit with the single interest rate used in previous studies and recognizing that with financial sector deregulation and innovation, the single interest rate does not adequately capture the opportunity costs of money. The last section offers some concluding remarks on our research
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