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Cointegration, Error Correction and the Demand for Money in Bangladesh

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  • Ahmed, Mansur

Abstract

The demand for money is a critical component in the formulation of and implementation of monetary policy. A well-defined and stable money demand function is a necessary condition for monetary policy to have predictable effect on the macroeconomic variables. This paper applies the advanced technique of cointegration to estimate the demand for money balances in the case of Bangladesh and evaluates stability of the equations. The analysis shows that there exist a long-run relationship between real money, real income, inflation, and interest rate that remains stable over time. The long-run properties emphasize that both inflation and interest rate have negative effects on real money demand, whereas real income has positive effects. The long-run relationship is finally embedded in a dynamic equilibrium correction model. The short-run dynamic parsimonious error correction models for both money demand functions were estimated and these were free from the conventional econometric problem faced by other studies. The stability of the equations and coefficients were highly encouraging.

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Bibliographic Info

Paper provided by University Library of Munich, Germany in its series MPRA Paper with number 21026.

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Date of creation: 15 Dec 2007
Date of revision: 10 Jul 2009
Handle: RePEc:pra:mprapa:21026

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Keywords: Money Demand; Unit Root Test; ECM; Bangladesh.;

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  1. Akhtar Hossain, 1993. "Financial Reforms, Stability of the Money Demand Function and Monetary Policy in Bangladesh: An Econometric Investigation," Indian Economic Review, Department of Economics, Delhi School of Economics, vol. 28(1), pages 85-100, January.
  2. Andrew D. Crockett & Owen J. Evans, 1980. "Demand for Money in Middle Eastern Countries (La demande de monnaie dans les pays du Moyen-Orient) (Demanda de dinero en países del Oriente Medio)," IMF Staff Papers, Palgrave Macmillan, vol. 27(3), pages 543-577, September.
  3. Bischoff, Charles W & Belay, Halefom, 2001. "The Problem of Identification of the Money Demand Function," Journal of Money, Credit and Banking, Blackwell Publishing, vol. 33(2), pages 205-15, May.
  4. Heller, H Robert & Khan, Mohsin S, 1979. "The Demand for Money and the Term Structure of Interest Rates," Journal of Political Economy, University of Chicago Press, vol. 87(1), pages 109-29, February.
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