Long-run Money Demand Function Research Articles

Are Stock Prices and the Turkish Money Demand Function Related?

Using the Autoregressive Distributed Lag (ARDL) and Granger causality test, this study demonstrates that M1 and M2 money demand cointegrates with real income, deposit interest rate, real exchange rates, and real stock prices. Real income, deposit interest, and exchange rates are significant determinants of the Turkish economy’s long-run M1 and M2 money demand. Furthermore, our findings reveal that the wealth effect of real stock prices outweighs the substitution effect within the Turkish economy. The impact of real stock prices on M1 and M2 money demand is positive and statistically significant in the long run. While M2 is more responsive to changes in real stock prices, M1 exhibits greater stability than M2. Therefore, policymakers must recognise the significant role of the stock market in the long-run money demand function within the Turkish economy and its impact on the effective implementation of monetary policy.

Long-Run Money Demand Function: Search for Stability in Twenty (20) Non-EMU Member Countries

This study examined the long-run money demand function in search for stability in twenty (20) Non-EMU member countries by applying Co-integration, an ARDL bounds test, CUSUM, and CUSUM squared estimation techniques to data spanning 1996 – 2019. We found co-integrating relationship between money demand and its determinants for all the countries under consideration (19 out of 20) except for Sweden. Stability in the money demand was also confirmed in seven (7) countries (Russia, Hungary, Montenegro, Bosnia, Bulgaria, Romania, and Croatia) based on both the CUSUM test results and CUSUM squared test. The remaining countries exhibited partial stability as indicated by the non-simultaneous stability of the CUSUM and CUSUM squared test. The divergence and heterogeneity found in the money demand functions and its determinants in these countries only give further impetus to their non - membership in the Eurozone. Hence there is the need for stability and convergence in the monetary policy management and money demand function to be admitted into the Eurozone holding other conditions fixed.

Exchange rate changes and money demand in Albania: a nonlinear ARDL analysis

A good part of the empirical literature on money demand focuses on searching for a stable long-run money demand function, an essential part of a successful monetary policy. Beyond the typical money demand specification, which includes income and interest rates, Mundell (Can J Econ Polit Sci 29:475–485, 1963) made a case for the exchange rate as an important determinant of money demand working through currency substitution. This paper contributes a new approach to test the short- and long-run effects of currency fluctuations on money demand in Albania, a small open economy without deep financial markets. More specifically, we examine the case for asymmetric effects of exchange rate fluctuations on money demand by using a nonlinear adjustment mechanism within an ARDL model. Using data for 1996–2016 from Albania, we show that the money demand is stable in both the linear and nonlinear specifications. The nonlinear model reveals an asymmetric effect of exchange rates on money demand, with depreciations reducing money demand, likely due to a substitution effect amplified by a relatively dollarized economy.

Long-Run Money Demand Function and Stability among Sixteen (16) West Africa Countries

This study employs annual time series data from 1982 to 2019 for sixteen (16) West Africa countries to investigate the stability of money demand in these countries and the feasibility of the proposed West African Monetary Zone. From a standard money demand function to a bounds test method, co-integration and error correction model, we found significant heterogeneity and divergence across the sixteen (16) countries. The highlight of the findings is that co-integration of the money demand function is only recorded in Ghana but exhibited partial stability from the CUSUMSQ (cumulative sum squared) test. In Nigeria, the biggest economy in West Africa has no co-integration and is only partially stable from the results of the CUSUM test. The significant divergence across these countries as indicated by the test of co-integration, CUSUM (cumulative sum) test, CUSUMSQ (cumulative sum squared) test, the short and long-run factors and error correction in the event of a shock, makes it crucial for the need to include country specific idiosyncratic monetary policy features in the event of a monetary zone in West Africa, and crucial to ensure convergence in their money demand function.

On the Markov Switching Welfare Cost of Inflation

This paper uses the Markov switching approach to account for instabilities in the long-run money demand function and compute the welfare cost of inflation in the United States. In doing so, it circumvents the problem of data-mining of some earlier seminal contributions on these issues, allowing for complicated nonlinear dynamics and sudden changes in the parameters of the money demand function. Moreover, it extends the sample period, and investigates the robustness of results to alternative money demand specifications, monetary aggregation procedures, and assumptions regarding dynamics aspects of the money demand specification.

On the Markov switching welfare cost of inflation

This paper uses the Markov switching approach to account for instabilities in the long-run money demand function and compute the welfare cost of inflation in the United States. In doing so, it circumvents the problem of data-mining of some earlier seminal contributions on these issues, allowing for complicated nonlinear dynamics and sudden changes in the parameters of the money demand function. Moreover, it extends the sample period, and investigates the robustness of results to alternative money demand specifications, monetary aggregation procedures, and assumptions regarding dynamics aspects of the money demand specification.

Currency Substitution And Stability Of Money Demand In Ghana

Monetary policymakers and economists in Ghana have become very disconcerted about the policy implications of the widespread demand for and gradual shift to the use of foreign currency in the economy in recent years. The question of whether the mounting trend of dollarization provides evidence of currency substitution has remained an empirical quest. The purpose is to empirically establish whether the data provides evidence of currency substitution. The method employed models a long-run money demand function within the portfolio balance framework, which distinguishes between capital mobility and currency substitution and also accounts for the pre and post inflation targeting monetary policy regime. The estimation technique follows the cointegration and error correction framework using the Autoregressive Distributed Lag model for annual data from 1960–2013. The variables used are real money balances (defined in both narrow and broad terms) and real income, domestic interest rates, foreign interest rates, and exchange rates. The study reports that there is a stable long-run relationship between real money balances and the determinants. The results highlight that the income elasticity for narrow money is close to one but less than unity for broad money. The coefficient of the interest rate variable is negative for narrow money but positive for broad money pointing out differences in the definition of the two categories of money. Also, whereas the coefficient for returns on foreign bonds is negative for both narrow and broad monetary aggregates, the exchange rate variable remains positive throughout. The findings reveal that, although there is no empirical evidence to support currency substitution, exchange rates and foreign interest rates are significant factors in the domestic money demand dynamics. The validity of foreign interest rate and/or the expected depreciation of the domestic currency in the long-run money demand equation capture the existence of capital mobility. The implication is that domestic agents use foreign currencies together with the domestic currency, although the domestic currency remains the legal tender for domestic transactions. The results underscore the importance of developments in foreign interest rates and exchange rates for fiscal, monetary, and exchange rate policies in Ghana. The policy implications of these findings have been deliberated to provide a guide for policy choices in the emerging economy.

Theoretical compliance of money demand function of Sri Lanka

This paper derives the monetarist version of broad money demand function for Sri Lankan economy using the quarterly data for the period from 1988: Q1 to 2012: Q4. This study employs both Johansen and Juselius (1990) multivariate method and Granger’s (1987) two-step method for cointegration to obtain structural values of the long-run money demand function: The stability of the model is tested using recursive coefficients and cumulative sum of squared residuals (CUSUM) tests. Results obtained from both co-integration testes suggest that the income elasticity of broad money demand is equal to one. Hence, it would provide an important guidance for the monetary authorities to regulate money supply as the intermediate target in order to achieve the final goal/goals of economic and price stability via the monetary transmission mechanism. This study concludes that growth of money over and above the real GDP growth will result inflation. The structural estimate received for inflation is higher than that of the real Treasury bill rate. Both the estimates are in theoretically expected signs and are also statistically significant. It means that public in Sri Lanka tend to substitute money for more real assets than the alternative financial assets during the time of higher inflation. Our tests on the stability of the broad money demand function confirmed that it is stable over time.

Theoretical compliance of money demand function of Sri Lanka

This paper derives the monetarist version of broad money demand function for Sri Lankan economy using the quarterly data for the period from 1988: Q1 to 2012: Q4. This study employs both Johansen and Juselius (1990) multivariate method and Granger’s (1987) two-step method for cointegration to obtain structural values of the long-run money demand function: The stability of the model is tested using recursive coefficients and cumulative sum of squared residuals (CUSUM) tests. Results obtained from both co-integration testes suggest that the income elasticity of broad money demand is equal to one. Hence, it would provide an important guidance for the monetary authorities to regulate money supply as the intermediate target in order to achieve the final goal/goals of economic and price stability via the monetary transmission mechanism. This study concludes that growth of money over and above the real GDP growth will result inflation. The structural estimate received for inflation is higher than that of the real Treasury bill rate. Both the estimates are in theoretically expected signs and are also statistically significant. It means that public in Sri Lanka tend to substitute money for more real assets than the alternative financial assets during the time of higher inflation. Our tests on the stability of the broad money demand function confirmed that it is stable over time.

Financial Innovations and Their Implications for Monetary Policy in Kenya

This study investigates the effect of financial innovation on monetary policy in Kenya during the period 1998–2013; that is, whether the waves of financial innovation that have occurred during this period have impacted the long-run stability of the money demand relations. Results obtained through the autoregressive distributed lag approach to cointegration show that the fast pace of financial development in Kenya has not caused structural shifts in the long-run money demand relation. Although the test for cointegration for the monetary aggregate M1 were inconclusive, the error correction estimates and stability test using the cumulative sum (CUSUM) of squares of recursive residuals show the long-run money demand function to be stable. The CUSUM results for M3 also show some instability in some periods, and the results show that the broad money demand is well cointegrated with its determinates. Given that broad money (M3) has been the operational target for the Central Bank of Kenya, monetary targeting was a feasible policy stance for Kenya during the period of study.

Structural Breaks and the Long-Run Stability of Demand for Real Broad Money Function in Nigeria: A Gregory-Hansen Approach

This study examines the long-run demand for real broad money function and its stability in Nigeria for the period from 1970 to 2012 inclusive. The study employs the Augmented-Dickey Fuller and Phillips-Perron tests for unit root, the Gregory and Hanson (1996a; 1996b) cointegration test to capture endogenous structural breaks in the cointegrating vectors of Nigerian long-run money demand function, cumulative sum of recursive residuals (CUSUM) and cumulative sum of recursive residuals squares (CUSUMSQ) tests for structural stability proposed by Brown et al. (1975). In estimating the canonical specification models, extended specifications are also presented. The results of the cointegration test suggest that demand for real broad money went through a regime shift in 2005. The results further confirm that there exists a long-run relationship amongst real broad money demand, real income, real domestic interest rate, real exchange rate, rate of inflation and foreign interest rate. However, the result of CUSUMSQ shows that the demand for money function is stable, but has undergone some temporary periods of instability. Hence, the apex bank in Nigeria can target the broad money (M2) aggregate to achieve macroeconomic objectives.

Evidence on Structural Instability in the Japanese Money Demand Function

The main purpose of this study is to re-investigate the long-run Japanese M2 money demand function and its stability over the period of 1970:Q1 to 2010:Q4. This study uses the bounds testing approach to cointegration within the autoregressive distributed lag (ARDL) framework to examine the presence of a cointegration relationship. The rolling regression procedure is then incorporated into the ARDL cointegration test to investigate the stability of the cointegrating relationship between money demand and its determinants in Japan. With the full sample, this study confirms that real M2 money demand, real income, real interest rates and real exchange rates are cointegrated. However, the evidence of the rolling ARDL cointegration test implies that the cointegrating relationships are not stable over time, indicating that the Japanese M2 money demand function is also unstable. In line with the rolling ARDL cointegration results, the recursive Chow breakpoint F-test and the Quandt likelihood ratio (QLR) test also suggest the same instability outcome. JEL Classification Codes: C22; E41

Reconsidering the welfare cost of inflation in the US: a nonparametric estimation of the nonlinear long-run money-demand equation using projection pursuit regressions

This paper, first, estimates the appropriate, log–log or semi-log, linear long-run money-demand relationship capturing the behavior US money demand over the period of 1980:Q1–2010:Q4, using the standard linear cointegration procedures found in the literature, and the corresponding nonparametric version of the same based on projection pursuit regression (PPR) methods. We then, compare the resulting welfare costs of inflation obtained from the linear and nonlinear money-demand cointegrating equations. We make the following observations: (i) the appropriate money-demand relationship for the period of 1980:Q1–2010:Q4 is captured by a semi-log function; (ii) based on the estimation of semi-log cointegrating equations, the welfare cost of inflation was found to at the most lie between 0.0131 % of GDP and 0.2186 % of GDP for inflation rates between 0 and 10 %, and; (iii) in comparison, the welfare cost of inflation obtained from the semi-log non-linear long-run money-demand function, derived using the PPR method, for 0–10 % of inflation ranges between 0.4930 and 1.9468 % of GDP. However, the standard errors associated with the welfare cost estimates obtained from PPR relative to the linear models tend to indicate that the nonlinear money demand provides more precise estimates of the welfare costs primarily for higher rates of inflation.

Financial Liberalization and Demand for Money: A Case of Pakistan

Literature in economics has identified many channels through which the financial liberalization may affect demand for money. There are evidences of stability as well as instability of demand for money due to financial development for developing economies. The objective of the current study is to examine the effect of financial liberalization on demand for money in Pakistan, i.e. whether financial liberalization has affected the demand for money or not. The issue is important as stable demand for money function is a prerequisite for formulating and operating monetary policy. To achieve the objective JJ cointegration and auto regressive distributed lag (ARDL) to the cointegration is employed to estimate the long-run equilibrium relationship between broad money M 2 and composite financial liberalization index along with other determinants of demand for money like gross domestic product, real deposit rate and exchange rate. In order to assess the stability of the model, the parameter constancy tests, i.e. recursive residuals, CUSUM and CUSUMSQ tests have been applied. The empirical results indicated that for broad money, there exists long-run money demand function. The financial liberalization, gross domestic product and real deposit rate positively affect the demand for money in the long as well as short-run.

Long-run money demand in OECD countries: what role do common factors play?

This article examines the long-run money demand function for 11 OECD countries from 1983Q1 to 2006Q4 using panel data. The distinction between common factors and idiosyncratic components using principal component analysis allows for the detection of cross-member cointegration and the determination as to whether national or international sources are responsible for the non-stationarity of money and its determinants. Indeed, the finding that the common factors are I(1) while the idiosyncratic components are I(0) indicates that cross-member cointegration may exist and non-stationarity in the variables is primarily driven by common international trends. Furthermore, it is found that the impact of income on money demand is positive, whereas it is negative for the interest rate, exchange rate and stock prices. Except for the income elasticity of money demand, all estimated long-run coefficients are larger for the common factors of the variables than for the variables themselves. This article provides evidence that the exchange rate is an important determinant of money demand, whereas the results for the stock prices are ambiguous. Finally, the results of a panel-based error-correction model suggest that several domestic money stocks converge to a common international equilibrium relationship between the common factors.

The Macro-Economic Reform And The Demand For Money In India

This paper is an attempt to estimate the short-run and long-run money demand functions in India during the 90s. The paper tries to closely follow the methodologies laid down in Chow (1966), Hendry (1980), Rose (1985) and Hwang (1985). The main findings of the paper are: 1) permanent income is not an appropriate representation of the scale variable, 2) the positive interest elasticity of demand for money in the short-run, 3i) limited ability of economic agents in removing disequilibrium of past period, and 4) rejection of the real adjustment hypothesis.

Long-Run Money Demand in OECD Countries – Cross-Member Cointegration

This paper examines the long-run money demand function for 11 OECD countries from 1983 to 2006 using panel data and including wealth. The distinction between common factors and idiosyncratic components using principal component analysis allows to detect cross-member cointegration and to distinguish between international and national developments as drivers of the long-run relation between money and its determinants. Indeed, cointegration between the common factors of the underlying variables, i.e. cross-member cointegration, indicates that the long-run relationship is mainly driven by international stochastic trends. Furthermore, it is found that the impact of income on money demand is positive, while it is negative for the interest rate and stock prices. The estimated (semi-)elasticities of money are larger for the common factors than for the original variables, except the income elasticity. Finally, the results of a panel-based error-correction model suggest that money demand converges to an international cross-member equilibrium relation of the common factors.

The Demand for Money in Sierra Leone Revisited

AbstractThis paper uses Johansen's cointegration methodology to estimate Sierra Leone's money long run demand function for the 1964-2005 period. It finds a stable long-run relationship between the quantity of real money balances and its determinants. Secondly, all the estimated coefficients have their expected signs. Additionally, as expected in economies with under-developed financial systems, Sierra Leone's long-run money demand function is unit income-elastic and interest-rate inelastic. Thus, the study provides support for the neoclassical money demand specification. Additionally, it reaffirms the central findings of Kallon (1992).

Structural changes and the US money demand function

Previous literature on the stability of the US money demand function suggests mixed results. In this article, we study the stability of the money demand function from the standpoint of structural changes in the function. We first investigate if a stable money demand function can be found for the US for the period from the first quarter of 1959 to the fourth quarter of 2000. The results show that a stable long-run money demand function does not exist for the sample period under consideration. We then estimate unknown structural break points in the variables of the money demand function using Bai and Perron's (1998) method and test if there is a stable relationship in each sub-sample period of the break points. The results show that a stable relationship exists for each sub-sample period. The estimated income elasticity and interest rate semi-elasticity are relatively smaller than Ball's (2001) estimates, but consistent with his argument.

Investigating M3 money demand in the euro area

Euro area monetary growth has exceeded its target since 2001. Likewise, recent empirical studies did not find evidence in favour of a stable long-run money demand function. In contrast to the bulk of the literature, we are able to identify a stable long-run money demand relationship. This result is obtained when the analysis is done without the short run homogeneity restriction between money and prices. The basic equation can be improved by allowing for asymmetric adjustment. In a low inflation environment, opportunity costs of holding money have decreased. Thus, the apparent monetary overhang is reconciled within standard models.