The Money Demand Relationship in Saudi Arabia: An Empirical Investigation

Abstract

The empirical estimates for the money demand function reported here are based on quarterly time series for Saudi Arabia for the period 1962/I to 1981/IV. The money demand function estimated in this article is novel in that it takes into account the potential effect of external monetary and financial factors on domestic money de‐mand in the open economy of Saudi Arabia. The empirical results show that these external factors (foreign interest rates and exchange rates) do play an important role in the Saudi money demand function. Hence, the Saudi monetary authorities should not ignore the response of domestic money demand to these external factors in formulating their stabilisation policies. The empirical evidence also indicates that the inflationary expectations and permanent real income variables exert significant influences on money demand, with the latter variable exhibiting a unitary long‐run elasticity. Finally, the estimated money demand equation is found to be structurally stable over time.