Money Demand in an Open Economy: The Case of Argentina 1993-2006

The existence of a stable money demand function is critical when designing and implementing monetary policy. This is even more relevant in the current context of Argentina where the central bank establishes targets for monetary aggregates. In turn, it is also important that such function takes into account the open economy characteristics of Argentina. This paper presents an estimation of a multivariate model of money demand in Argentina during the period 1993-2006 within a context of an open economy. As a result, besides the classical determinants (such as GDP, expected inflation and domestic interest rates) non-traditional determinants, such as the interest rates of US Treasuries and the multilateral real exchange rate are introduced into the model. The cointegration analysis was performed using Johansen methodology. Successive tests proved a significative cointegration relation among the money demand, GDP, the domestic interest rate, the international interest rate and the multilateral real exchange rate. Despite this, the coefficient related to the international interest rated did not have the sign anticipated by the theory. The final step was an estimation of a vector error correction model (VEC) which turned out to be stable. In turn, the multilateral real exchange rate variable proved to have a considerable influence in the long term: a real depreciation of the exchange rate undermines the confidence in domestic currency, decreasing the demand for real balances through a substitution effect with foreign currency. This influence of real exchange rate on the money demand is consistent with other papers, such as Gay (2004). Consequently, in the future, it will be important to include variables accounting for the characteristics of Argentina as an open and emerging economy when the purpose is to describe money demand behavior.