Abstract
The escalation in dollar rates and the price instability in the Nigerian economy went through some significant structural and institutional changes such as the liberalization of the external trade, the elimination of price and interest rate controls, and the adoption of a managed float exchange rate system as well as the changes in monetary policy including innovations in the banking sector. Hence, the study examines the impact of financial development on money demand in Nigeria by means of ARDL approach. It examined the quarterly returns of M2, exchange rate (EXR), inflation rate (IFR), currency in credits to private sector (CPS) and circulation (CIC). The data span from 1991 to 2018. The study utilizes regression model techniques where the regression model’s residual is tested for Cointegration using Engle-Granger residual approach, the significances of the variable’s co-movement are checked by pairwise Granger Causality tests and ARDL and VECM are estimated in order to account for the short run and long run relationship among the variables. From the empirical results, Engle-Granger residuals and pairwise Granger Causality tests confirm cointegration among variables. The ARDL and VECM confirm the long run relation between money demand (M2) and financial development variables: CPS and CIC. ARDL models (short run relationship) are estimated for exchange rate and inflation rate. Long run (VECM) analysis has confirmed significance of financial development variables (CPS and CIC) with positive sign; implies that money demand function is stable in long run. The VECM granger causality results reveal that bidirectional causality exists between currency in circulation and money demand in both short and long run. Unidirectional causal relationship exists between credits to private sector and money demand in both short and long run. Hence, government should pay more attention on financial development and ensure a coordination of both fiscal and monetary policy.
Highlights
The demand for money refers to the total amount of riches held by the households and companies; this is affected by several factors such as income levels, interest rates, price levels and uncertainty
It examined the quarterly returns of M2, exchange rate (EXR), inflation rate (IFR), currency in credits to private sector (CPS) and circulation (CIC)
The results showed that instability in money demand due to many changes in monetary policy of Japan. [11] tested the stability of money demand function for Tonga using approaches of LSE Hendry’s General to Specific (GETS) and Johansen’s Maximum Likelihood (JML)
Summary
The demand for money refers to the total amount of riches held by the households and companies; this is affected by several factors such as income levels, interest rates, price levels (inflation) and uncertainty. The bounds test shows the exists of long run cointegration relationship among demand for real money balances, real GDP and interest rate in case of both narrow and broad monetary aggregates. An earlier study by [13] examined the effect of financial liberalization on money demand in Uganda based on data (1982Q4 to 1998Q4) He employed Johansen cointegration test and found that M2 and its determinants are cointegrated. [18] investigated the money demand function a case study of Nigeria over the period 1970 to 2010 They have established stability of M1 by using Chow breakpoint test, (CUSUM) and (CUSUMSQ) tests by incorporating real income, short term interest rate, real expected exchange rate, expected inflation rate and foreign real interest rate. It could contribute to the available proposed literature on the concept of money demand in the scientific communal used by experienced top practitioners all around the world
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