Stable Money Demand Function Research Articles

Does digital finance change the stability of money demand function? Evidence from China

Understanding the stability of the money demand function is crucial for determining how money impacts inflation and output, and optimizing monetary policy operations. Our study, using China as a case study, examines the potential effects of digital finance on this stability through cointegration technology. We found that digital finance influences the stability of money demand functions differently across monetary aggregates: it leaves M0 unaltered, doesn't influence the unstable M1, but does disrupt the formerly stable M2. We further investigate how two key services of digital finance - payment and asset management - affect the stability of M0, M1, and M2 demand functions. For payment services, our findings suggest the stability impact on the money demand function follows the order of M0 > M1 > M2. In contrast, for asset management services, the impact is ranked inversely. Consistent with recent studies, our data indicates that employing the Divisia index softens the impact of digital finance on the stability of money demand functions. Moreover, it's essential to monitor the pace of reform and understand how the behaviors of unique economic entities impact the money demand function, while concurrently promoting a deeper reform of interest rate liberalization.

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.

Determinants of Real Money Demand in India.

The foundation of a nation's monetary policy is determined by the components of its money supply. The advent of technological advancements in the banking industry has led to the development of digital payment methods that serve as substitutes for the currency in circulation. The proliferation of digital payment methods has an impact on real money demand, thereby disturbing the money supply-demand equilibrium of the country. The current study made an effort to evaluate the factors that affect the real money demand in India, taking into account the use of digital payment methods like NEFT, debit cards, and credit cards, as well as macroeconomic variables like GDP, the exchange rate, and price level. The study used secondary time series data from the RBI database for the period from 2005–06 to 2020–21. The linear regression model was used to estimate the real money demand function, and it was found that income, exchange rate, and NEFT transactions positively influenced real money demand. Debit cards had a negative impact on the real money demand, concluding that an increase in the value of debit card transactions caused a decline in the real money demand. The study’s findings will help the RBI to enable methods to incorporate digital payment instruments in the components of the money supply, thereby maintaining a stable money demand function.

Long-Run Stability of Money Demand and Monetary Policy: The Case of South Korea

The current paper aims to investigate the stability of money demand in the case of Korea. Since the economic reforms in Korea faced considerable structural changes, it was difficult to formulate a stable money demand function. The use of unit root and cointegration tests with structural breaks suggest that economic and financial deregulations have influenced the stability of money demand. The cointegration results suggest a cointegration vector in all models, implying a long-run relationship. Furthermore, the estimated long-run equations show that the elasticity of long-run industrial production to real money is positive and very close to one. Finally, the exogeneity test shows a long-run, one-way, causal relationship from industrial production to M1 and a bi-directional causality between M1 and interest rate in both models. In the case of M3, there are long-run, one-way, causal relationships from industrial production and interest rate to M3 in both models.

Денежное предложение в истории макроэкономической мысли: 50 оттенков эндогенности

The paper considers the evolution of the money supply concept in economics through the lens of contemporary discussion on the degree of its endogeneity. It is stated that the model of exogenous money supply formation, widespread in the literature and actively criticized in recent decades, is an artifact of macroeconomic thought. Its dominance lasted a very short time period, and various forms of endogeneity were attributed to money supply much more often in the course of monetary theory development. Authors cover the debates between the currency and banking school in the XIX century, the birth of the theory of money multiplier, Keynes’ position, the monetarist view of money supply and its criticism by Post- Keynesians. Particular attention is paid to the turn in views within the mainstream, from the Real Business Cycles doctrine to state-of-the-art models of the New Synthesis. It is emphasized that the complete exogeneity of money supply is a distinctive feature only of the monetarist approach, which has relied on the specifi c assumption of the stability of money demand function. The paper shows that, despite the visible convergence between the New Keynesian and Post- Keynesian positions, based on the modeling of interest rate targeting rather than money supply targeting by the central bank, fundamental differences still remain between two camps regarding the endogeneity mechanism.

The Stability of Money Demand Function in Sri Lanka: A Bound Cointegration Approach

The importance of demand for money has become a prominent research topic in monetary economics due to its role in monetary policy formulation. This paper investigates empirically the determinants of money demand function in Sri Lanka over the period 1977-2019. This study estimates both short run and long run money demand function using monetary aggregates M1 and M2 based on time series data. The explanatory variables used in the study comprised with stability variables such as Inflation rate, exchange rate and Gross Domestic product, Opportunity cost variables such as short run interest rate and long term interest rate and other macroeconomic variables such as government expenditure, interest rate spread and economic crisis. Annual time series data has been taken to estimate eterminants of money demand. The estimates of the long run relationship is obtained by using bound cointegration technique and the vector error correction technique was used to estimate of the short run dynamics of the long run equation. Findings of the study confirmed real GDP, interest rate, government expenditure, inflation rate, interest rate spread and economic crisis has significant relationship with the money demand in Sri Lanka. According to the stability test, the empirical results show that the both M1 and M2 money demand functions are stable for the period 1977-2019. Results indicate that both M1 and M2 are suitable for the monetary policy formulation. Thus, Sri Lanka’s current practice of monetary targeting framework using broad money as an intermediate target is viable. This study provides the policy challenges that Sri Lankan economy meets to develop favorable macroeconomic environment in order to manage money demand for a sustainable growth.

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.

English

The purpose of this study is to investigate the stability of money demand function in emerging countries using the annual data over the period 1987 to 2018. The panel data was analyzed applying both static and dynamic panel models. With the static panel analysis, the random effect method is found to be an appropriate model to determine the factors that affect money demand in emerging countries. The findings of random effect method reveal real income affect money demand positively while exchange rate and real interest rate influence money demand negatively. The results of dynamic panel approach show that real income has positive impact on broad money demand while exchange rate, real interest rate and inflation negatively influence broad money demand in the long-run. The dynamic panel approach confirms that inflation has a significant impact on money demand in addition to the variables found to significantly influence money demand with the random effect method of static panel approach. This implies that dynamic panel model better estimates the determinants of money demand function as compared to static panel model. The stability analysis of each country confirms stable money demand function. The error correction model reveals any deviation from the equilibrium is corrected each year in the selected emerging countries. Therefore, the monetary policy makers can incorporate the outcome of this study as additional input for the implementation of effective monetary policy in the selected countries of emerging economies.    Key words: Autoregressive Distributed Lag (ARDL) model, BRICS, dynamic panel model, money demand, pooled mean group, random effect method.

The empirical properties of euro area M3, 1980-2017

This paper revisits the empirical properties of euro area M3 over the years 1980 to 2017. We estimate a CVAR model that includes wealth in addition to conventional drivers. Our empirical analysis identifies three long run cointegration relations - one of which can be interpreted as a stable money demand function. We detect that wealth effects coming from movements of stock prices and housing wealth had a positive effect on the long-run money demand for M3 and on output. Moreover, we confirm leading indicator properties of M3 excess liquidity for inflation, in particular at horizons between 1 and 2 years.

Stability of Money Demand Function in the SAARC Region: A Panel Co-Integration Approach

This study explores the causality relationships between money demand, real income, price, and interest rate by focusing on South Asia for the period...

Demand for Money Function in Case of Philippines: An Empirical Analysis

An effective formulation of monetary policy provides an empirical and coherent model of money related with demand. In order for the monetary authorities to understand the demand for the purpose of money function, the steadiness of money demand is important as it leads towards an application of efficient monetary policy. In order to examine the stability of money demand function of Philippines, following study was conducted with broad money, real asset price index, GDP deflator, real GDP, long-term interest rate and short-term interest rate. For empirical investigation, unit root test, cointegration, and Granger-Causality tests were used. However, the findings of the cointegration suggests that cointegration reveals there is presence of linear combinations, and results shows that there are four cointegrating equations present. Therefore, it is evident that there are at least 4 cointegrating relations between the variables. Hence, some of macroeconomic indicators can be used to predict the broad money due to presence of vector. However, the Granger-Causality shows that no macroeconomic variable granger cause broad money (M1). Therefore, the selected macroeconomic indictors RS, LS, CPI, GDP deflator, RGDP and AP/P cannot be used to predict the variation in the broad money (M1) in case of Philippines. This means the money demand function in Philippines is not stable, and for this purpose further investigation is suggested by increasing sample size and time window in quarterly or semi-annually.

Assessing the Stability of Money Demand Function in Saudi Arabia

This paper aims to investigate the stability of money demand function for Saudi Arabian economy over the period of 2007:Q1-2018:Q4 by applying various structural break tests. The obtained results from the utilized tests reveal the stability of money demand function. The estimated money demand function also shows the impact of income on money demand is consistent with theory expectations in addition to the positive impact of exchange rate and interest rate on the demand for money. Moreover, the estimated error correction model indicates that money demand needs about 5 quarters to adjust to its equilibrium path in case it deviates from the steady state condition.

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.

Financial liberalization and long-run stability of money demand in Nigeria

A stable money demand function is essential when using monetary aggregate as a monetary policy. Thus, there is need to examine the stability of the money demand function in Nigeria after the deregulation of the financial sector. To achieve this, the study employed CUSUM (cumulative sum) and CUSUMSQ (CUSUM of square) tests after using autoregressive distributive lag bounds test to determine the existence of a long run relationship between monetary aggregates and their determinants. Results of the study show that a long-run relationship holds and that the demand for money is stable in Nigeria. In addition, the inflation rate is found to be a better proxy for an opportunity variable when compared to interest rate. The main implication of the study is that interest rate is ineffective as a monetary policy instrument in Nigeria.

The demand for Divisia money in the United States: evidence from the CFS Divisia M3 aggregate

ABSTRACTIn this paper, we analyse the demand for real money balances in the United States for the period 1990Q1–2017Q2 using a novel Divisia monetary aggregate developed by Barnett et al. (2013). Unlike simple-sum aggregates, Divisia aggregates take into account the different degrees of ‘moneyness’ of each monetary asset. In addition, Divisia aggregates have shown to be empirically superior to simple-sum aggregates, providing stable money demand functions for different periods and countries. In a first stage, we test for cointegration and estimate a long-run equilibrium model. In a second stage, we estimate an error correction model to study the short-run dynamics. Consistent with previous research, our findings show the existence of a stable money demand function, which suggests that monetary aggregates, when properly measured, can be useful tools in the conduct of monetary policy.

Financial Sector Reforms, Monetary and Output Uncertainties and the Behavior of Money Demand in Kenya: The Divisia Index Approach

The financial sector reforms implemented by the Central Bank of Kenya (CBK) resulted in rapid financial innovation (such as the popular M-Pesa mobile money services) growth, and expansion of several interest earning financial instruments. These developments affect the definition and composition of monetary aggregates, posing a question on the correctness of the current money measures used by CBK. The simple sum aggregates were identified with several theoretical and empirical shortcomings. The rapid financial sector development might affect the stability of money demand function. This study constructs Divisia monetary aggregates for Kenya over the period of 2000’s first quarter to 2015’s third quarter and applies the ARDL method in investigating the stability of money demand function. For the first time, monetary uncertainty and output uncertainty variables are introduced to the Kenyan money demand model. The results reveal that both monetary and output uncertainty has significant influence on money demand in Kenya. This implies that omitting the two variables in the Kenya money demand function might lead to a wrong specification. The money demand function is stable over the period. It means that monetary aggregates targeting is the right framework for monetary policy formulation by the CBK.

The demand for banking and shadow banking services

We explore the hypothesis that the substitutability/complementarity relationship between banking and shadow banking services is a major factor affecting the transmission mechanism of monetary policy. We take the parametric approach to demand analysis, which allows estimation and testing in a systems-of-equations context, and use the Minflex Laurent flexible functional form for the underlying aggregator function. We relax the homoskedasticity assumption and assume Markov regime switching to relax the assumption of fixed consumer preferences. We generate inference consistent with neoclassical microeconomic theory and provide evidence against simple-sum money supply measures. We also show that the emergence of shadow banking has increased the stability of money demand functions. This means that money supply measures based on a nonlinear aggregator function might be a better measure of the stance of monetary policy than the interest rate.

The Demand for Banking and Shadow Banking Services

We explore the hypothesis that the substitutability/complementarity relationship between banking and shadow banking services is a major factor affecting the transmission mechanism of monetary policy. We take the parametric approach to demand analysis, which allows estimation and testing in a systems-of-equations context, and use the Minflex Laurent flexible functional form for the underlying aggregator function. We relax the homoskedasticity assumption and assume Markov regime switching to relax the assumption of fixed consumer preferences. We generate inference consistent with neoclassical microeconomic theory and provide evidence against simple-sum money supply measures. We also show that the emergence of shadow banking has increased the stability of money demand functions. This means that money supply measures based on a nonlinear aggregator function might be a better measure of the stance of monetary policy than the interest rate.