Money Demand Relationship Research Articles

How justified is abandoning money from monetary policy? Evidence from dynamically simulated ARDL

The stable money demand function is a crucial policy tool of the monetary policy of any central bank, which links the monetary sector of an economy to its real sector. Notably, after the global financial crisis of 2007–08, the role of money has come to be envisaged as an essential issue while formulating and conducting the monetary policy, especially at zero lower bound. It is crucial to know whether money demand is stable for inferring a sound monetary policy. To this end, the present study examines the short- and long-run money demand relationship and its stability in India from 2006:Q3 to 2019:Q4. The study has employed a dynamically simulated autoregressive distributed lag (ARDL) cointegration approach, which shows a well-specified and stable money demand in India after incorporating the inflation forecast variable as one of the essential determinants along with other covariates. Furthermore, the dynamically simulated impulse response also supports the economic relationship among variables. The current finding of stable money demand implies a policy implication in terms of focusing on monetary aggregate, in the ongoing flexible inflation targeting framework, as one of the essential information or indicator variables, which acts as a long-term assessment of short-term interest rate setting behaviour to achieve the macroeconomic goals.

The impact of uncertainty on money demand in the UK, US and Euro area

We estimate money demand functions for the UK, the Euro area and the US using Divisia monetary aggregates and investigate the extent to which the uncertainty caused by Brexit and Covid have affected these relationships. Our cointegrated VAR analysis shows that for all three economies Brexit and/or Covid have had some impact on the stability of money demand functions. We find that including a measure of stock market volatility in the money demand specifications helps re-establish stability of the models, particularly for the UK and the Euro area. We also explore the uncertainty and money demand relationship in the context of a Markov-switching model. We find that the effect of uncertainty on the demand for money is more pronounced during periods of heightened uncertainty. The findings of this study lend support to studies calling for Divisia aggregates to be given a more prominent role in policymaking, especially when interest rates are in the zero lower bound environment and are less informative about the stance of monetary policy.

International currency substitution and the demand for money in the euro area

Using quarterly data for the period from 1983:Q1 until 2019:Q4, we identify a stable money demand relationship for the euro area M3, with the US long-term interest rate as a regressor, together with the domestic interest rate and income. This specification is consistent with the open economy liquidity services approach to money demand, in light of which the ownership of money is separate from portfolio decisions. Our results suggest international currency substitution, pointing to interdependency of monetary policies, even in a context of floating exchange rates. In the short-run analysis, we find that excess liquidity helps predict nominal money but not the price level. In general, our findings cast doubt on the usefulness of the information content of M3 to analyse prospective inflation in the euro area. • Using quarterly data, we identify a stable money demand function for the EA M3. • We find a significant influence of the US interest rate on the EA money demand. • Results point to interdependency of monetary policies, even under float. • We find that excess liquidity helps predict nominal money, but not the price level. • Our evidence casts doubt on the usefulness of M3 to analyse prospective inflation.

Asymmetric Impact of Exchange Rate Changes on Money Demand in Malaysia

The relationship between exchange rate and money demand has long been debated among macroeconomists due to its impact on the stability of money demand and monetary policy. Following the significant depreciation in the currency exchange associated with the political instability in Malaysia in recent years, examining the relationship between exchange rate and money demand is crucial to ensure the monetary policy remains prudent. This study examined the asymmetric impact of exchange rate changes on money demand in Malaysia using both linear and nonlinear ARDL approaches. The findings reveal that the money demand responds asymmetrically to exchange rate changes both in the short and long run, whereby the response to a negative shock (local currency depreciation) outweighs the positive shock (local currency appreciation). The result also suggests that the substitution effects dominate the exchange rate and money demand relationship. Consequently, with the economic and political instability continuing, the currency exchange is expected to depreciate further, contributed by the strong substitution effects. This will greatly affect the stability of money demand and the monetary policy and thereby call upon a policy intervention to strengthen the currency exchange and sustain the long-run economic performance.

Money demand under a fixed exchange rate regime: the case of Saudi Arabia

ABSTRACT This paper reviews earlier studies and shows that the money demand (MD) relationship under a fixed exchange rate (ER) regime differs from that under a floating ER regime, mainly due to the limited role of monetary policy in the former regime. It then empirically demonstrates that an open-economy model augmented with country-specific factors is a better framework for characterizing the MD function under a fixed ER regime by applying cointegration and equilibrium correction modeling to the Saudi data as a case study. The main message for monetary authorities is that there are other factors, besides those theoretically predicted, shaping MD under a fixed ER regime. This information is important for providing adequate money supply to support economic growth and maintain the stability of the fixed ER, as well as for checking the stability of the MD to make appropriate policy decisions.

The Economic Uncertainty with Money Demand: Empirical Evidence for Selected Developed and Developing Countries

An important element of the empirical research on demand for money is that many published papers focus on common issues of economic activity rather than on economic uncertainty to identify a stable money demand function. Therefore, by encompassing economic uncertainty in money demand study cannot be used to disprove its precision simply because of model misspecification in general use and an intricate process of data collection. This paper uses a sample of four selected developed countries and five selected developing countries. By using the dynamic heterogeneous panel co-integration test of autoregressive distributed lag, this paper examines the money demand relationship that considering economic uncertainty and two additional control variables, namely exchange rate and inflation. The paper’s findings suggest that the economic uncertainty is an important explanatory indicator about unknown economic events that may assist in fine-tuning money demand stability, and that the exchange rate and the inflation rate roles as well as the income and the interest rate roles remain significant in the process of central bank’s monetary decision making, which eventually help to enhance money demand controls for a sensible monetary transmission mechanism.

The demand for Divisia Money: Theory and evidence

A money-in-the-utility function model is extended to capture the distinct roles of noninterest-earning currency and interest-earning deposits in providing liquidity services to households. It implies the existence of a stable money demand relationship that links a Divisia monetary aggregate to consumption as a scale variable and the associated Divisia user-cost dual as an opportunity cost measure. Cointegrating money demand equations of this form appear for the Divisia M2 and MZM aggregates in quarterly United States data spanning the period from 1967:1 through 2019:1. The identification of a stable money demand function over a period that includes the financial innovations of the 1980s and continues through the recent financial crisis and Great Recession suggests that a properly measured aggregate quantity of money can play a role in the conduct of monetary policy. That role can be of greater prominence when traditional interest rate policies are constrained by the zero lower bound.

Analysing money demand relation for OECD countries using common factors

ABSTRACTThis article investigates the existence of a long-run money demand relation for a panel data consisting of 13 OECD countries. The analysis is based on the most recent data. The existence of a long-run money demand relation is tested with two new meta-analytic panel cointegrating rank tests which are robust to cross-sectional dependence. Cross-sectional dependency in the data generating process is modelled by unobserved common factors. The observed data are decomposed into idiosyncratic and common components, and these two components are analysed separately to find out the driving forces of the long-run stationary relationship. The evidence shows that the long-run money demand relation is driven by the cross-unit cointegration. Finally, the long-run relation is estimated by taking the common factors into account.

Money and velocity during financial crises: From the great depression to the great recession

This study models the demand for a broad monetary aggregate (M2) from the Great Depression through the Great Recession. Key to the model is the interaction between a measure of time-variation in economic agents’ perceived financial risk and an index of the cost of portfolio adjustment. The finding of a useful money demand relationship suggests that skepticism regarding the indicator role of a broad, liquid money aggregate as a policy guide may be exaggerated. Further, our model provides some guidance for policymakers who face the challenge of unwinding large balance sheets as risk premia return to normal and velocity adjusts.

Money, Inflation, and Unemployment in the Presence of Informality

This paper studies the implications of informality for the long run relationship between inflation, output and unemployment in developing economies. I present a monetary dynamic general equilibrium model with search frictions in both labor and goods markets and where informality is an equilibrium outcome. Policies that lead to a larger informal sector result in an upward shift in both the money demand relation and the Beveridge curve. In contrast, financial development reduces informality and shifts both the Beveridge curve and the money demand relation downwards. An increase in the long run inflation rate affects unemployment through two channels: On the one hand, higher inflation reduces the surplus of monetary trades which lowers firms' profits, job creation and increases unemployment. On the other hand, it shifts firms' hiring decision from high separation and cash intensive informal jobs to low separation formal jobs which reduces unemployment. I calibrate the model to the Brazilian economy and find that the existence of a large informal sector significantly dampens the long run effects of monetary policy on unemployment and output. This result points to the importance of accounting for informality in the conduct of monetary policy in developing economies.

Determinants of Money Demand in Ghana

This paper examines the factors that influence money demand in Ghana using the ARDL approach as the baseline estimator. We find strong evidence of existence of long-run equilibrium relationship between money demand and its determinants. The results also indicate that expected inflation and real exchange rate are the key determinants of money demand both in the short-run and long-run. The role of real interest rate is only recognized in the long-run whereas the impact of financial innovation resulting from the on-going financial sector reforms only affect the transitional dynamics of the money market conditions. There is also an ample evidence of instability in the money demand relationship as a result of inflation and exchange rate volatility. Moreover, given that the wealth effect phenomena holds in Ghana, the paper concludes by suggesting that policies directed towards regulating and maintaining stable exchange rates and low and steady inflation would be necessary to maintain stable money demand and thus enhance the effectiveness of monetary policy in Ghana.

The Stability of Long-Run Money Demand in Western Balkan Countries: An Empirical Panel Investigation

Abstract The goal of this paper is to examine the stability of money demand (M1) in five Western Balkan countries using quarterly data from 2005Q1 to 2014Q4. The dynamic ordinary least squares – DOLS method was used to find the long-run relationships in a money demand model. The empirical results identify the long-run money demand relationship among real M1 nominal interest rate, exchange rate, inflation and a dummy variable for the effect of the European debt crisis. The estimated long-run coefficients are, respectively −0.086, 0.519, 0.002 and 0.030. Our findings imply that real money demand in Western Balkan countries was stable in the analyzed period.

Unconventional monetary policy and money demand

This paper investigates the usefulness of the money demand relationship in times of unconventional monetary policies by cointegration methods. Our empirical evidence shows the existence of stable long run money demand functions even in the period of interest rates near the zero bound, both for the US economy and the euro area. Evidence is based on standard monetary aggregates, i.e. MZM for the US and M3 for the euro area. The recent monetary policy shifts towards unconventional measures do not lead to a breakdown of money demand. The relationships do not show instabilities and are robust against the Lucas critique.

Unconventional Monetary Policy and Money Demand

This paper investigates the usefulness of the money demand relationship in times of unconventional monetary policies by cointegration methods. Our empirical evidence shows the existence of stable long run money demand functions even in the period of interest rates near the zero bound, both for the US economy and the euro area. Evidence is based on standard monetary aggregates, i.e. MZM for the US and M3 for the euro area. The recent monetary policy shifts towards unconventional measures do not lead to a breakdown of money demand. The relationships do not show instabilities and are robust against the Lucas critique.

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.

Stability of Money Demand Function in Pakistan

The role, which money demand function plays in monetary policy formulation has attracted a lot of research studies to analyze this macroeconomic phenomenon. In the wake of current global and local economic and political upheavals, it is imperative to revisit the stability of money demand function. The study used the time series data and applied latest econometric techniques to find out the long run and short run money demand relationship. Moreover, all the three official monetary aggregates were used for finding out the most stable monetary demand relationship, which could provide correct signals for monetary policy formulation. The study found that broader monetary aggregate (M 2 ) was the proper aggregate, which provided stable money demand function for Pakistan. The real GDP was positively related to the demand for real balances, while opportunity cost of money was negatively related. The study found that the role of financial innovation, in explaining the demand for money warrants attention in formulating monetary policy.

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.

Money demand stability: A case study of Nigeria

Monetary policy in Nigeria aims is to achieve price and monetary stability. During the 1980s and 1990s, monetary targeting was the dominant monetary policy framework in Nigeria. However, in 2006 the Central Bank of Nigeria (CBN) adopted the new monetary policy framework through which short-term interest rates are adjusted to achieve stability in the value of the domestic currency. This paper has presented an empirical investigation into the demand for Nigerian real narrow money (M1) over the period 1960–2008 in an attempt to identify whether the CBN were right to adopt the new monetary policy framework. In doing so, we estimate alternative (canonical and extended) specifications of M1 demand using structural change methods. Our results suggest that the canonical specification is well-determined. Although the money demand relationship went through a regime shift in 1986, it is largely stable. These findings favour the use of supply of money as an instrument of monetary policy, thus lending limited support for the new monetary policy framework.

Money Demand In South Africa Revisited: A Detailed Analysis Of Different Models

Many macroeconomists acknowledge the importance of behavior in a money demand relationship when formulating an efficient monetary policy. Many efforts have been made to estimate the money demand in function using many different specifications. This paper discusses South African empirical literature review of money demand. It revealed that different methods have been used to analyze the demand for money in South Africa, such as the linear function approach, the partial stock adjustment model, and the buffer stock disequilibrium money model. This study also discovered that few studies are done using co-integration and error correction methods and not all of these studies show that the money demand function in South Africa is stable. Implication for theory and practice, as well as area of future research, are also discussed in the study.

Measuring the welfare cost of inflation in south africa: a reconsideration

In this paper, using the Fisher and Seater (1993) long-horizon approach, the writers estimate the long-run equilibrium relationship between money balance as a ratio of income and the Treasury bill rate for South Africa over the period 1965:02 to 2007:01, and, in turn, use the obtained estimates of the interest elasticity and the semi-elasticity to derive the welfare cost estimates of inflation, using both Bailey’s (1956) consumer surplus approach and Lucas’ (2000) compensating variation approach. When the results are compared to welfare cost estimates obtained recently by Gupta and Uwilingiye (2008), using the same data set, but basing it on Johansen’s (1991, 1995) cointegration technique, the values are less than half of those obtained in the latter study. These range from 0.16 percent to 0.36 percent of GDP for the target-band of three percent to six percent of inflation. The paper thus highlights the fact that welfare cost estimates of inflation are sensitive to the methodology used to estimate the long-run equilibrium money demand relationships.