Financial Deregulation, Economic Uncertainty and the Stability of Money Demand in Australia

Abstract

This article investigates the financial deregulation, economic uncertainty and the stability of money demand (M1 & broad money (BM)) in Australia for the periods between 1976:2 and 2008:4. We use Johansen procedure of cointegration to estimate the long‐run stationary relationship between Australian monetary aggregates and the explanatory variables. We use generalised autoregressive conditional heteroscedasticity (1, 1) model to construct an economic uncertainty index. The results suggest that there is evidence of long‐term relation between money (M1), economic activity, interest rate and price for the pre‐deregulation subperiod. However, there is no evidence of long‐run equilibrium relation between real M1 and its determinants for the baseline specification. However, the model with uncertainty index confirms a stable long‐run relationship. Moreover, we found no cointegration relation among BM, real GDP and long‐term interest rate for post‐regulation and for the entire sample for the traditional money demand equation. However, we have consistent evidence of long‐run equilibrium relation between BM, real activity and short‐term interest rates for subperiods and for the entire sample period when we account for economic uncertainty.