Empirical Analysis of Money Demand Function in Algeria: 2003-2014

This paper presents an empirical investigation into the level and stability of money demand (M2) in Algeria between 2003 Q1 and 2014 Q4. In addition to estimate some specification, alternative specifications are presented that include additional variables to proxy for the cost of holding money. The paper search for the role of monetary authority in its control of real cash balances through money supply. If money demand in Algeria is stable, the Central Bank of Algeria can predict the level of money supply and there will be no inflationary pressure in the economy. The empirical analysis of the study involves application of tests for co-integration and test of stability was conducted. The variables of the study are real money (M2), real interest rate (TI), consumer price index (CPI) and gross domestic product (GDP), and co- integration test revealed long run equilibrium relationship. The test of stability shows that real money demand function in Algeria is stable as neither the CUSUM nor the CUSUMSQ plots cross the 5 percent critical boundaries. The study recommended that there should be a clear-cut distinction between short run and long run objectives as the monetary authority, for example, can use inflation to reduce the level of money demand in the long run and increase it in the short run.