Demand for Real Money Balances by the Business Sector: An Econometric Investigation

Monetary economics provides one of the important tools, that is monetary policy, to deal with the macroeconomic problems of the economy. It is concerned with the supply of money and the demand for money. It is often assumed that the money supply is exogenously determined by the authorities and the demand for real money is determined by the market. The demand for money is of crucial importance in the conduct of monetary policy. It helps to understand macroeconomic activities and to prescribe appropriate policy instruments to deal with macroeconomic problems. The effectiveness of the monetary policy, however, depends on the shape and stability of the estimated demand for money function. Empirical studies of the money demand in Pakistan concentrated on the estimation of aggregate money demand function by using conventional regression analysis. The main criticism against the aggregate models of the money demand is that these models lumped two different sectors of the economy, such as the household sector and the business sector. Further, it is argued that these two sectors have diversified behaviour. Their money demand behaviour is subject to different requirements. Sectoral money demand behaviour is thoroughly investigated in developed counties but a very thin literature on the estimation of money demand function by the business sector in developing countries is available, for example, Unger and Zilberfarb (1980) and Cameron and Qayyum (1994). Econometric methodology of these studies is mainly concerned with the estimation of two types of money demand functions such as long-run static and shortrun partial adjustment mechanism. However, the researchers employing the technique of cointegration in the empirical testing of money demand function have cast serious doubt on the results of these studies.