Long-run stability of money demand and monetary policy: The case of Algeria

Abstract

Since the start of the oil counter-shock in June 2014, Algeria has experienced unprecedented twin deficits. The excessive monetisation of the public deficit coupled with other deep anomalies in the economy of this country acutely calls for reconsideration of its monetary policy. To this end a prior study of the long-run stability of money demand is needed. We estimate the demand for money for monetary aggregates M1 and M2, and cash in Algeria over the period 1979–2019, and study its long-run stability. We show that the transaction motive is significant for all three aggregates, especially for the demand for cash, reflecting the weight of informal economy “practices”. The elasticity of the scale variable is very close to unity for M2 and M1, and even equal to unity for cash demand (1.006). The elasticity of inflation is also significant for all three aggregates, although its level is higher in the case of cash demand (−6.474). Despite the persistence of certain financial repression mechanisms, interest rate elasticity is significant for all three aggregates, but higher for M1 and cash. The same observation is made for elasticity of the exchange rate, reflecting the effect of monetary substitution, especially for M1 and cash. Finally, our study concludes that the demand for money in terms of M1 remains stable, the same observation being confirmed for the M2 aggregate. However, the demand for fiat currency proves not to be stable. The consequences for the optimal design of monetary policy in Algeria are clearly stated.