Re-examining money demand function for South Asian economies

Abstract

This study explores the stability of the money demand function in South Asia using the cash-in-advance theory of cointegrated monetary predictors. Due to the stationarity of the variables, the study employs CS-ARDL (cross-sectional augmented autoregressive distributed lags), and the ARDL models for panel and country-specific analysis, respectively. The short- and long-term elasticities disclose robust and significant statistical evidence of a nexus between the real monetary aggregate and the predictors, in the panel and across South Asia. The findings also reveal that real income, the real exchange rate, and foreign interest rates positively influence the real monetary aggregate, whereas the domestic interest rate and the inflation rate have contractionary effects. Besides, the results indicate that the money demand function is stable in Bangladesh, Bhutan, India, Pakistan, and the Maldives, while the findings support only partial stability in Afghanistan, Nepal, and Sri Lanka. The findings suggest that South Asian countries make significant allowance for the vital substitutional effects of currency on domestic holdings when articulating monetary policies. It also suggests that South Asian countries may need to build stronger coordination with respect to their monetary attempts as a “regional bloc” rather than autonomous monetary policies.