Abstract
The gross domestic product (GDP) as a scale variable in the macro-money demand function is justified only on the simplifying but verifiable assumption that the individual-sector GDPs have the same marginal money demand propensities. This assumption is easily verifiable by replacing the aggregate GDP with the services sector and commodity sector GDPs as two scale variables. The money demand propensities differ between these two sectors. To empirically verify this, a variable elasticity of substitution model is posited with these two sector GDPs as scale variables. This novel model permits us to estimate the parameter of elasticity of substitution between the two-sector GDPs .We expect the elasticity estimate to be greater than unity first and decrease towards unity later in the post-liberalization period 1992-2012 and this ensures a unitary income elasticity of demand for money for the aggregate GDP. For the pre-liberalization period (1971 to 1991) we expect the substitutability between the two sectors to be either less than unity or even negative. The policy implication of disparate sector-GDP growth rates for money demand should not be ignored in an emerging economy of India, where the GDP structure evolves towards invariance as in a developing economy.
Highlights
It is well known that in a structurally evolving emerging market economy, inter-sector interactions may create disparate money-demand propensities and they are likely to create significant influence on the macro-money demand function. These very disparate sector money demand propensities can be identified in three different ways; Firstly, changes in the sector composition —concentration or diversification — can show up as bias in the macro-money demand function [Ganti, 1996 and 2002] Secondly, these can end up as stored up information hidden behind the income elasticity of money demand [Ganti and Bhamidipati, 2011]; and [Ganti, Telidevara and Acharya, 2016]
The rest of the study is organized as follows: Section[2] provides brief explanation as to why distinguish between commodities and services for studying macro-money demand; section[3] posits a variable elasticity of substitution model of money demand and derives the elasticity of substitution formulae between commodities and services; section 4 presents a discussion of the regression results and section 5 concludes with a summary and remarks
Most econometric studies excluding those by [Ganti, 1996 and Ganti et al, 2016] relating to the macro-money demand function estimation have relied upon the gross domestic product (GDP) as the scale variable and interest rate as the opportunity cost variable in the specification
Summary
It is well known that in a structurally evolving emerging market economy, inter-sector interactions may create disparate money-demand propensities and they are likely to create significant influence on the macro-money demand function. The rest of the study is organized as follows: Section[2] provides brief explanation as to why distinguish between commodities and services for studying macro-money demand; section[3] posits a variable elasticity of substitution model of money demand and derives the elasticity of substitution formulae between commodities and services; section 4 presents a discussion of the regression results and section 5 concludes with a summary and remarks
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