Function has been subjected to extensive theoretical and empirical research because of its crucial importance as a fundamental building block in macroeconomic theory and as a critical component in the formulation of monetary policy.
A fixed money supply poses the well-known problem of deflation as supply cannot react to changes in money demand
To study about the relation of money demand
and its determinants is a prime issue since the stability of money demand
function is helpful to make an effective monetary policy.
The main objective of this paper is to investigate empirically on the nexus of financial liberalisation with money demand
using annual data for Sri Lanka.
This paper examines the quarterly observations of the 1993-2009 period and uses cointegration analysis and an error correction model (ECM) to estimate money demand
functions in order to analyze the long-term effects and short-run dynamics in the money demand
For example, higher real incomes or declining opportunity costs of holding money generate a higher money demand
7 and a negative interest rate elasticity as suggested by standard money demand
analysis, the estimates for M1 indicate very low price elasticities of approximately 0.
We follow this approach in our study by identifying a money-multiplier shock that captures unexpected changes to demand for currency and the demand for reserves, a real money demand
shock, and a monetary policy-induced shock to the monetary base.
Because, a consistent stable relationship between money demand
and its determinants like stock prices and exchange rate is pre-requisite for monitoring and targeting of monetary aggregates.
The existing literature on demand for money reveals that not much attention has been given to analyze the relationship between money demand
and its determinants in developing countries like Pakistan.
Kasibhatla, and Moschos Scoullis, tests the stability of money demand
by a co-integration technique in "The Values of the Determinants and Tests of Stability of the Money Demand
Function of the United States.
Nevertheless, reflecting the view that the demand for money became unstable in the early 2000s, some commentators have reported that the ECB has "downgraded" the role of money demand
functions in its strategy.