Applied Demand for Money Study in Developing Countries

This chapter discusses empirical study of demand for money in Ghana, a developing country. Its time series data is sourced from the IMF’s International Finance Statistics, World Bank, and Bank of Ghana data sources. This demand for money is built from the microeconomic foundation developed in previous chapters. We have employed an error-correction model which allows us to study short-run dynamics, and at the same time use cointegration to study its long-run effects. The error-correction term measures the speed at which a deviation from long-run equilibrium is adjusted back to it. Specification of the demand for money equation is principally determined by the underlying microeconomic structure of shopping time model of money demand. Thus, the cointegrated long-run equation of real cash balances is explained by real income as a scale variable, and real interest rate as an exogenous variable. In an empirical study, we find that the forecasting ability of the shopping time model can be improved by the researcher if s/he addresses seasonal variations by dropping variables which introduce autocorrelation in the study. Additionally, variables which are used to explain real cash balance must be tested to ensure that they are exogenous. Wu and Hausman’s test is also used to confirm that the money supply is super endogenous, and price and real income are super exogenous. Thus, significant results of endogeneity test, weak exogeneity test, and homogeneity test property of real income and prices, and stability test of real cash balance in the aforesaid study, cannot be gainsaid.