Abstract
The Historically, research focusing on the money demand function developing economies (especially Eastern European transition economies) was a difficult undertaking because of under-developed financial systems and the unavailability of data. This study aims to assist in filling this gap in the literature by employing three different estimation techniques to estimate the M1 and M2 money demand functions for Hungary. The study uses quarterly data for an 18-year period, obtained from the IMF’s International Financial Statistics database. The results based on the bounds testing procedure as well as the other two approaches confirm that a stable, long-run relationship exists between the demand for money and its determinants. The results’ robustness is enhanced by the similarities between the results of the various approaches used in the study. The money demand function can therefore theoretically serve as a tool to measure the effect of monetary policy decisions and in determining what parameters of the money demand function to adjust in order to yield the required effects. It is suggested that, in the case of Hungary the M1 money demand function might be the most appropriate model on which monetary policy decisions should be based. Keywords: Money demand, Hungary, stability, ARDL, cointegration
Highlights
The estimation of a stable money demand is a crucial element of conducting monetary policy, as it allows monetary authorities to play an active role in affecting adjustment in the monetary supply variables (Achsani, 2010:54)
The importance of estimating a stable and well-defined money demand function can be a daunting task in the case of developing countries in which limited data availability, hyperinflation and undeveloped financial systems could prove to be significant constraints
As was argued by Dritsakis (2011), that the M1 money demand function might be the most appropriate model on which monetary policy decisions should be based. This argument is made given the relative stability of the autoregressive distributed lag (ARDL) specification of the M1 money demand function
Summary
The estimation of a stable money demand is a crucial element of conducting monetary policy, as it allows monetary authorities to play an active role in affecting adjustment in the monetary supply variables (Achsani, 2010:54). Research on the money demand function has historically been conducted in developed economies due to the substantial data availability and welldeveloped financial systems (Calza & Zaghini, 2010:1663; Johansen, 1992:313). Given the substantial institutional and structural changes that Hungary has undergone since the early 1990s, it could be argued that the relationship between the monetary aggregate and the explanatory variables in the money demand function had changed drastically. This could have had an impact on both the existence of a long-run relationship and the stability thereof. The Johansen approach to cointegration and the vector error correction model have not been employed in research on the money demand function and this is another facet in which this study contributes to the literature
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