Stability of money demand function in Pakistan

Omer, Muhammad (2009): Stability of money demand function in Pakistan. Published in: SBP Research Bulletin , Vol. 6, No. 2 (2010)

Abstract

This paper is an attempt to contribute to the ongoing debate: should central bank of Pakistan adopt inflation targeting or continue with the monetary targeting as a monetary policy strategy? A pre-requisite for monetary targeting strategy is a stable money demand function, which in turn requires stability in velocity. Instability in velocity on the other hand is believed to stem from the volatility of the interest rate. The paper explores the stability of velocity of money in Pakistan. The results show that the base and broad money velocities are independent of the interest rate fluctuations. It is also found that all the three velocities (with respect to M0, M1, and M2) have stable relationship with their determinants. These findings validate use of monetary aggregates as nominal anchor.

• Item Type: MPRA Paper
• Language: English
• Keywords: monetary targeting, income velocity of money, money demand function
• Subjects: E - Macroeconomics and Monetary Economics > E5 - Monetary Policy, Central Banking, and the Supply of Money and Credit > E51 - Money Supply ; Credit ; Money Multipliers; E - Macroeconomics and Monetary Economics > E5 - Monetary Policy, Central Banking, and the Supply of Money and Credit > E58 - Central Banks and Their Policies; E - Macroeconomics and Monetary Economics > E5 - Monetary Policy, Central Banking, and the Supply of Money and Credit > E52 - Monetary Policy; E - Macroeconomics and Monetary Economics > E4 - Money and Interest Rates > E41 - Demand for Money

References

Abbas, K. and F. Husain (2006). “Money, Income and Prices in Pakistan: A Bivariate and Tri-variate Causality.” South Asia Economic Journal, 7(1): 55-65.

Akbari, A. and W. Rankaduwa (2006). “Inflation Targeting in a Small Emerging Market Economy: The Case of Pakistan.” SBP Research Bulletin, 2: 169-190.

Akinlo, A.E.(2006). “The Stability of Money Demand in Nigeria: An Autoregressive Distributed Lag Approach”, Journal of Policy Modeling, 28: 445-452.

Arango, S. and M.I. Nadiri (1981). “Demand for Money in Open Economies,” Journal of Monetary Economics, 7 (January): 69-83.

Asano, H. (1999). “Financial Deregulation and stability of Money Demand: The Australian case”, Australian Economic Papers, 38(4): 407-421.

Bahmani-Oskooee, M. (2001). How Stable is M2 Money Demand Function in Japan?”, Japan and the World Economy, 13: 455-461.

Bahmani-Oskooee, M. and M. T. Bohl (2000). “German Monetary Unification and the Stability of Long-run German Money Demand Function.” Economics Letters, 66: 203–208.

Bahmani-Oskooee, M. and Chomsisengphet (2002). “Stability of M2 Money Demand Function in Industrial Countries”, Applied Economics, 34: 2075-2083.

Bahmani-Oskooee, M. and G. Shabsigh (1996). “ The demand for money in Japan: Evidence from cointegration analysis.”, Japan and the World Economy, 8: 1–10.

Bahmani-Oskooee, M., and H. Rehman (2005). “Stability of Money Demand Function in Asian Developing Countries” Applied Economics, 37:773-792.

Banerjee, A., J. Dolado, J. W. Galbraith and D. F. Hendry (1993). Co-integration, Error Correction and the Econometric Analysis of Non-stationary Data. Oxford: OUP.

Bilquees, F. and R. Shehnaz (1994). “Income Velocity and Per Capita income in Pakistan: 1974-75 to 1991-92”, The Pakistan Development Review, 33: 4(2) :985 – 995.

Bordo, M., L. Junong, and P. Siklos (1997). “Institutional Change and Velocity of Money: A Century of Evidence.”, Economic Inquiry, 35 (Oct), 710- 724.

Bordo, M.D., and L. Jonung (1981).“The Long-Run Behavior of the Income Velocity of Money in Five Advanced Countries, 1870-1975: An Institutional Approach.” Economic Inquiry, (January): 96-116.

Bordo, M. D., and L. Jonung (1987). The Long-Run Behavior of the Velocity of Circulation: The International Evidence. Cambridge: Cambridge University Press.

Bordo, M. D., and L. Jonung (1990). “The Long Run Behavior of Velocity: The Institutional Approach Revisited.” Journal of Policy Modeling, 12: 165-197.

Bordo, M. D., and L. Jonung (2004). “Demand for Money: An Analysis of the Long Run Behavior of the Velocity of Circulation”. Cambridge: Cambridge University Press.

Boughton, J.M. (1981). “Recent Instability of the Demand for Money: An International Perspective,” Southern Economic Journal, 47(January): 579-597.

Brown, R., J. Durbin, and J. Evans (1975). “Techniques for Testing the Constancy of Regression Relations Over Time.”, Journal of the Royal Statistical Society, Series B, 37: 149–63.

Butter, F.A.G. den, and M.M.G. Fase (1981).“The Demand for Money in EEC Countries.”, Journal of Monetary Economics, 8 (September): 201-230.

Chaudhry, M. A., and M. A. S. Choudhary (2006). “Why the State Bank of Pakistan should not Adopt Inflation Targeting.” SBP Research Bulletin, 2: 195-209.

Darrat, A. F., and A. Al-Mutawa (1996).“Modeling Money Demand in the United Arab Emirates”, The Quarterly Review of Economics and Finance, 36(1): 65-87.

Engle, R. F., and C.W. J. Granger (1987). “Cointegration and Error Correction: Representation, Estimation and Testing”. Econometrica, 55: 251–276.

Felipe, J. (2009). “Does Pakistan Need To Adopt Inflation Targeting? Some Questions”, SBP Research Bulletin, Vo 5(1): 113-161. SBP Karachi.

Frankel, J.A, and M.P. Taylor (1993). “Money demand and inflation in Yugoslavia, 1980-89”, Journal of Macroeconomics, 15, 455-481.

Friedman, M. (1956). “The Quantity Theory of Money – A Restatement.” In M. Friedman (Eds.). Studies in the Quantity Theory of Money, Chicago: University of Chicago Press.(pp. 3-21)

Goldfeld, S.M. (1973). “The Demand for Money Revisited,” Brookings Papers on Economic Activity, 3: 577-646.

Goldfeld, S.M. (1976). “The Case of Missing Money,” Brookings Papers on Economic Activity, 3: 683-.730.

Hafer, R. W., and D. W. Jansen,(1991). “The Demand for Money in the United States: Evidence from Cointegration Tests”, Journal of Money, Credit, and Banking, 23: 155–68.

Hafer, R.W., and A.M. Kutan (1994). “Économic Reforms and Long Run Money Demand in China: Implication for Monetary Policy”, Southern Economics Journal, 60, 936- 945.

Haug, A. A., and R. F. Lucas (1996). “Long Run Money Demand in Canada: In Search of Stability”, The Review of Economics and Statistics, 78(2): 345-348.

Hendry, D.F., and N.R. Ericsson (1991). “An Econometric Analysis of U.K. Money Demand.” [ed]In Monetary Trends in the United States and the United Kingdom, by Milton Friedman and Anna J. Schwartz.” American Economic Review, 8I (March): 8-38.

Hamori, N., and S. Hamori (1999). “Stability of Money Demand Function in Germany”, Applied Economics Letters, 6: 329-332.

Hoffman, D. L., and R. H. Rasche (1991). “Long-run Income and Interest Elasticities of Money Demand in the United States”, The Review of Economics and Statistics, 73: 665–74.

Johansen, S. (1988). “Statistical analysis of cointegration vectors”, Journal of Economic Dynamics and Control, 12: 231- 54.

Johansen, S. (1991). “Estimation and Hypothesis Testing of Cointegration Vectors in Gaussian Vector Autoregressive Models.” Econometrica, 59: 1551-1581.

Johansen, S. and K. Juselius, (1990). ‘Maximum Likelihood Estimation and Inference on Cointegration with Applications to the Demand for Money’, Oxford Bulletin of Economics and Statistics, 52: 169 - 210.

Kemal, A. (2006). “Is Inflation in Pakistan a Monetary Phenomenon?” Pakistan Development Review, 45: 213–220.

Khalid, A. M. (2006) “Is Inflation Targeting the Best Policy Choice for Emerging Economies? A Survey of Emerging Market Experiences and Lessons for Pakistan.” SBPResearch Bulletin, 2 (1): 145-165.

Khan, M. and A. Schimmelpfennig (2006). “Inflation in Pakistan.” Pakistan Development Review, 45: 185-202.

Kremers, J. J., N. R. Ericson, and J. J. Dolado (1992). “The Power of Cointegration Tests”, Oxford Bulletin of Economics and Statistics, 54: 325–47.

Laidler, E. W. D. (1993). ‘The Demand for Money: Theories, Evidence and Problems’, 4th edn, Harper Collins College Publishers, London.

Laurenceson, J. and J. C.H. Chai (2003).“Financial Reform and Economic Development in China”. Cheltenham: Edward Elgar.

Lee, C. and M. Chien (2008). “Stability of Money Demand Function Revisited in China”, Applied Economics, 40: 3185–3197.

Leventakis, J.A. (1993). “Modelling Money Demand in Open Economies Over the Modern Floating Rate Period,” Applied Economics, 25(August): 1005- 1012.

McNown, R. and M. S. Wallace, (1992).”Cointegration Tests of a Longrin Relatationship between Money Demand and Effective Exchange Rate”, Journal of International Money and Finance, 11: 107-14.

Mehra, Y.P. (1991). “An Error-Correction Model of U.S. M2 Demand,” Federal Reserve Bank of Richmond, Economic Review, 77(May/June): 3-12.

Mishkin, F.S. (2004): Economics of Money Banking and Financial Markets. 7th ed. Addison Wesley Series in Economics. USA.

Moinuddin (2009). “Choice of Monetary Policy Regime: Should SBP Adopt Inflation Targeting?” SBP Research Bulletin, 5(1): 1-30, Karachi. SBP.

Narayan, P. K. (2008). “Revisiting the US Money Demand Function: An Application of the Langranges Multiplier Structural Break Unit Root Test and the Bound Test for a Long- run Relationship”, Applied Economics, 40: 897-904.

Narayan, P.K, S. Narayan, and V. Mishra (2009). “Estimating Demand Function for South Asian Countries”, Empirical Economics, 36(3): 685-696.

Omer, M., and O. F. Saqib (2009). “Monetary Targeting in Pakistan: A Skeptical Note.” SBP Research Bulletin, 5(1): 53-81. Karachi. SBP.

Pesaran, H.M., Y. Shin, and R.J. Smith (2001), “Bounds Testing Approaches to the Analysis of Level Relationships,” Journal of Applied Econometrics, 16: 289-326.

Pesaran, M. H., and B. Pesaran (1997). Working with Microfit 4.0: Interactive Econometric Analysis. Oxford: Oxford University Press.

Pesaran, M.H. (1997). “The role of Economic Theory in Modeling the Long Run”, The Economic Journal, 107(1): 178-191.

Pesaran, M.H., and Y. Shin (1999). “An Autoregressive Distributed Lag Modeling Approach to Cointegration Analysis”, in S. Strom (ed.), Econometrics and Economic Theory in the 20th Century. The Ragnar Frisch Centennial Symposium, 1998, Cambridge University press, Cambridge.

Qayyum, A. (2006). “Money, Inflation and Growth in Pakistan.” Pakistan Development Review, 45: 203–212.

Ramchandran, M. (2004). ‘Do Broad Money, Output, and Prices Stand for a Stable Relationship in India?’, Journal of Policy Modeling, 26: 983-1001.

Rose, A.K. (1985). “An Alternative Approach to the American Demand for Money,” Journal of Money, Credit and Banking, 17(4): 439-455.

SBP (2001). “Pakistan: Financial Sector Assessment, 1990-2000”, SBP, Karachi. http://www.sbp.org.pk/publications/fsa/index.htm

SBP (2005). “Pakistan: Financial Sector Assessments 2005”, SBP, Karachi. http://www.sbp.org.pk/publications/FSA/2005/index.htm

SBP (2006). “Handbook of Statistics on Pakistan Economy”, SBP, Karachi. http://www.sbp.org.pk/departments/stats/PakEconomy_HandBook/index.htm

SBP (Various Issues). “Monthly Statistical Bulletin”, SBP, Karachi. http://www.sbp.org.pk/reports/stat_reviews/Bulletin/index.htm

Siklos, P. L. (1993). “Income Velocity and Institutional Change: Some New Time Series Evidence, 1870- 1986.” Journal of Money, Credit and Banking, (Aug): 377-92.