Financial Liberalization, Weighted Monetary Aggregates and Money Demand in Indonesia

Chin-Hong, Puah and Lee-Chea, Hiew (2010): Financial Liberalization, Weighted Monetary Aggregates and Money Demand in Indonesia. Published in: Labuan Bulletin of International Business & Finance , Vol. 8, (December 2010): pp. 76-93.

Abstract

This study investigates the significance of Divisia monetary aggregates in formulating the monetary policy in Indonesia. A money demand function has been constructed to compare the relative performance for Simple-sum M1 and M2 (SSM1 and SSM2) and Divisia M1 and M2 (DM1 and DM2) monetary aggregates. The econometrics testing procedures that have been utilized in the estimation include unit root test, cointegration test, Vector Error Correction Model (VECM), Granger causality test and residual test. Empirical findings indicate that only DM1 model yields credible result amongst all of the money demand models. The obtained coefficients for DM1 model are consistent with a prior theoretical expectation and carry plausible magnitudes. The DM1 model is satisfactory as proven by the diagnostic tests. Divisia monetary aggregates are proven not only theoretical superior but also empirical valid as useful measurement of money for the case of Indonesia. The central bank of Indonesia may consider using Divisia monetary aggregates as the policy variables in formulating monetary policy.

• Item Type: MPRA Paper
• Language: English
• Keywords: Money Demand; Divisia Money; VECM
• Subjects: C - Mathematical and Quantitative Methods > C3 - Multiple or Simultaneous Equation Models ; Multiple Variables > C32 - Time-Series Models ; Dynamic Quantile Regressions ; Dynamic Treatment Effect Models ; Diffusion Processes ; State Space Models; C - Mathematical and Quantitative Methods > C4 - Econometric and Statistical Methods: Special Topics > C43 - Index Numbers and Aggregation; E - Macroeconomics and Monetary Economics > E4 - Money and Interest Rates > E41 - Demand for Money

References

Anderson, R.G., Jones, B.E. and Nesmith, T.D. (1997). Introduction to the St. Loius monetary services index project. Federal Reserve Bank of St. Louis Review, January/February, 25-29.

Anglingkusumo, R. (2005). Stability of demand for real narrow money in Indonesia. Tinbergen Institute Discussion Paper, 51(4), 1-18.

Bahmani-Oskooee, M. and Rehman, H. (2005). Stability of the money demand function in Asian developing countries. Journal of Applied Economics, 37(7), 773-792.

Bahmani-Oskooee, M. and Shin, S. (2002). Stability of the demand for money in Korea. International Economic Journal, 16(2), 85-95.

Barnet, W. (1980). Economic monetary aggregates: an application of index number and aggregation theory. Journal of Econometrics, 14, 11-48.

Barnett, W., Chauvet, M. and Tierney, H.L.R. (2009). Measurement error in monetary aggregates: a markov switching factor approach. MPRA Paper, 13(2), 381-412.

Belongia, M. (1996). Measurement matters: recent results from monetary economics reexamined. Journal of Political Economy, 104(5), 1065-1083.

Chaisrisawatsuk, S., Sharma, S.C. and Chowdhury, A.R. (2004). Money demand stability under currency substituition: some recent evidence. Applied Financial Economics, 14(1), 19-27.

Cysne, R. (2000). Divisia indexes, money and welfare. Graduate School of Economics Getulio Vargas Foundation (Brazil), Economics Working Papers, 396.

Dahalan, J., Sharma, S.C. and Sylwester, K. (2005). Divisia monetary aggregates and money demand for Malaysia. Journal of Asian Economics, 15, 1137-1153.

Darrat, A.F., Chopin, M.C. and Lobo, B.J. (2005). Money and macroeconomic performance: revisiting divisia money. Review of Financial Economics, 14, 93-101.

Dickey, D.A., Jansen, D, W. and Thornton, D.L. (1991). A primer on cointegration with an application to money and income. Federal Reserve Bank of St. Loius, March/April, 58-78.

Drake, L. and Fleissig, A. (2006). Admissible monetary aggrates and UK inflation targeting. Oxford Economic Papers, 58, 681-705.

Eberl, K. (1998). Seasonal cointegration analysis of German money demand using simple-sum and divisia monetary aggregates. Diskussionsbeitr¨age der Katholischen Universit¨at Eichst¨att, Wirtschaftswissenschaftliche Fakult¨at Ingolstadt, 107.

Elger, T., Jones, B.E. and Nilsson, B. (2006). Forecasting with monetary aggregates: recent evidence for the United States. Journal of Economics and Business, 58, 428-446.

Fry, M. (1995). Money, Interest and Banking in Economic Development, 2nd edition. London: John.

Habibullah, M.S. (1998). Divisia money and income in Indonesia: some results from error-correction models, 1981:1-1994:4. Journal of Appplied Economics Letters, 5, 387-391.

Habibullah, M.S., Azali, M., Puah, C.H. and Baharumshah, A. Z. (2002). The relevance of monetary aggregates for monetary policy purpose in Malaysia. Borneo Review, 13(1), 1-12.

Hueng, C. (1998). The demand for money in an open economy: some evidence for Canada. North American Journal of Economics and Finance, 9(1), 15-31.

International Monetary Fund. International Financial Statistics, various issues. Washington, D.C.: IMF.

Ireland, P.N. (1995). Endogenous financial innovation and the demand for money. Journal of Money, Credit, and Banking, 27(1), 107-123.

James, G. (2005). Money demand and financial liberalization in Indonesia. Journal of Asian Economics, 16, 817-829.

Johansen, S. (1992). Testing weak-exogeneity and the other of cointegration in U.K. money demand data. Journal of Policy Modelling, 14, 313-334.

Johansen, S. and Juselius, K. (1990). Maximum likelihood estimation and inference on cointegration-with applications to the demand for money. Oxford Bulletin of Economics and Stastical, 52(2), 169-210.

Leong, C.M, Puah, C.H., Shazali, A.M. and Lau, E. (2010). Testing the effectiveness of monetary policy in Malaysia using alternative monetary aggregation. Margin - The Journal of Applied Economic Research, 4(3), 321-338.

Masih, A. M., Al-Elg, A. and Madani, H. (2009). Causality between financial development and economic growth: an application of vector error correction and variance decomposition methods in Saudi Arabia. Journal of Applied Economics, 41(13), 1691-1699.

Masson, P.R., Savastano, M.A. and Sharma, S. (1998). Can inflation targeting be a framework for monetary policy in developing countries? Journal of Finance and Development, 35(1), 34-37.

Narayan, P. (2007). Is money targeting an option for Bank Indonesia? Journal of Asian Economics, 18, 726-738.

Nelson, C.R. and Plosser, C.I. (1982). Trends and random walks in time. Journal of Monetary Economics, 10, 139-162.

Odularu, O.G. and Okunrinboye, O.A. (2009). Modeling the impact of financial innovation on the demand for money in Nigeria African. Journal of Business Management, 3(2), 039-051.

Puah, C.H., Habbibulah M.S., Lau, E. and Abu Mansor, S. (2006). Testing long-run monetary neutrality in Malaysia: revisiting divisia money. Journal of International Business and Economics, 6(1), 110-115.

Puah, C.H., Habibullah, M.S. and Abu Mansor, S. (2008a). Some empirical evidence on the quantity theoretic proposition of money in ASEAN-5. Pakistan Journal of Applied Economics, 18(1 & 2), 31-47.

Puah, C.H., Habibullah, M.S. and Abu Mansor, S. (2008b). On the long-run monetary neutrality: evedence from the SEACEN countries. Journal of Money, Investment and Banking, 2, 50-62.

Puah, C.H., Leong, C.M., Abu Mansor, S. and Lau, E. (2008). Revisiting money demad in Malaysia: simple-sum versus divisia monetary aggregates. Paper presented at International Conference on Business and Information (BAI2008), Seoul, South Korea.

Schunk, D. (2000). The relative forecasting performance of the divisia and simple sum monetary aggregates. Journal of Money, Credit, and Banking, 33(2), 272-283.

Schwert, G.W. (1987). Effects of model specification tests for unit root in macroeconomic data. Journal of Monetary Economics, 20, 73-103.

Thornton, D.L. and Yue, P. (1992). An extended series of divisia monetary aggregates. Federal Reserve Bank of St. Louis Review, November/December, 35-52.

Yue, P. and Fluri, R. (1991). Divisia monetary services indexes for switzerland: are they useful for monetary targeting? Federal Reserve Bank of St.Louis Review, September /October, 19-33.