Abstract
The purpose of this study is to investigate the stability of money demand function in emerging countries using the annual data over the period 1987 to 2018. The panel data was analyzed applying both static and dynamic panel models. With the static panel analysis, the random effect method is found to be an appropriate model to determine the factors that affect money demand in emerging countries. The findings of random effect method reveal real income affect money demand positively while exchange rate and real interest rate influence money demand negatively. The results of dynamic panel approach show that real income has positive impact on broad money demand while exchange rate, real interest rate and inflation negatively influence broad money demand in the long-run. The dynamic panel approach confirms that inflation has a significant impact on money demand in addition to the variables found to significantly influence money demand with the random effect method of static panel approach. This implies that dynamic panel model better estimates the determinants of money demand function as compared to static panel model. The stability analysis of each country confirms stable money demand function. The error correction model reveals any deviation from the equilibrium is corrected each year in the selected emerging countries. Therefore, the monetary policy makers can incorporate the outcome of this study as additional input for the implementation of effective monetary policy in the selected countries of emerging economies. Key words: Autoregressive Distributed Lag (ARDL) model, BRICS, dynamic panel model, money demand, pooled mean group, random effect method.
Highlights
Money provides a trade-off between the liquidity benefit of holding money and the interest advantage of holding working and fixed assets
The stability test was performed for each country using cumulative sum of recursive residuals (CUSUM) and cumulative sum of squares of recursive residuals (CUSUMSQ) tests
Random effect model was found to be an appropriate model compared to pooled model and Fixed effect model based on the pFtest and Hausman test
Summary
Money provides a trade-off between the liquidity benefit of holding money and the interest advantage of holding working and fixed assets. The stability of money demand ensures predictability of the variables, and reduces the possibility of an inflation bias. That means a stable money demand articulates that the changes in the elements of money demand equation can be predicted. The stability of money demand function reveals the variables that determine the quantity of demanded money remain consistent over time period. Stable money demand exists if the demand for money has a long-run cointegrating association with its determinants without any systematic changes in the regression coefficients
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