Abstract
This research work has employed vector error correction and cointegration techniques in order to estimate the elasticity of real money demand to macroeconomic variables such as industrial production index, exchange rates and short-term interest rates in the United Kingdom. Also, global financial crisis was introduced as an impulse variable to capture structural breaks inherent in the series. Empirical results showed that long-run relationships existed between real money demand and industrial production index, short-term interest rates, and exchange rates in the United Kingdom. The study showed that in the long-run, real money demand had more than unity elasticity with industrial production index in both economies. Real money demand has an inelastic relationship with short-term interest rates and exchange rates. Furthermore, results indicated that it would take long time for real money demand to adjust to its long-run equilibrium. Impulse response analysis revealed that any increase in short term interest rates will have negative effects on the real money demand in the medium to long-term. Whilst real money demand in the United Kingdom tend to be more significant in forecasting the Euro zone money demand, the latter tends to be negatively statistically significant in the former real money demand model. The financial crisis witnessed globally had negative effects on real money demand in the United Kingdom. Key words: Vector error correction, Cointegration, impulse response analysis, macroeconomic variables, long-run equilibrium, real money demand and financial crisis.
Highlights
Money demand models provide a structure, which helps to explain changes in money explained by advances in macroeconomic variables
Attribution License 4.0 International License. The stability of this relationship is usually assessed in a money demand framework, where money demand is linked to other macroeconomic variables like industrial production index and interest rates
This paper intend to use cointegration and error correction with unrestrictive dynamic techniques to justify the presence of contemporaneous relationships between real money demand, industrial production index, shortterm term interest rates and exchange rate in the United
Summary
Money demand models provide a structure, which helps to explain changes in money explained by advances in macroeconomic variables. This research work focuses on studying the elasticity by estimating long-run and shortrun money demand function for the United Kingdom by adopting the method of cointegration and error correction analysis. This paper intend to use cointegration and error correction with unrestrictive dynamic techniques to justify the presence of contemporaneous relationships between real money demand, industrial production index, shortterm term interest rates and exchange rate in the United
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