Estimation of Money Demand Function in Iran with Cointegration and Error Correction Models Approach

اقتصاد پولی مالی

Article 2, Volume 20, Issue 5, April 2013, Pages 1-26   

Document Type: علمی

DOI: 10.22067/pm.v20i5.34032

Authors

Mansour Khalili Araghi^* ; Hossein Abbasinejad; Yazdan Gudarzi Farahani

Abstract

The knowledge about the money demand function and its effecting factors is the most important ubject in Examination of the effects of monetary policies on economiy in order that the monetary policy can help monetary authorites to achive their goals by effecting money demand.
This paper estimates the demand of money in Iran over 1350-1390 period using co-integration and error correction methodology.
The analysis shows that narrow definition of money (M1), domestic gross production, real exchange rate, prices level and return rate on long-term deposit are integrated. Thus, using Johansen-Juselius cointegration approach, the long-term demand for money is specified and estimated.
Empirical results show that there are two co-integrated vectors among variables. In this model the coefficient of error correction term is equal to -0.52 which is found statistically significant. This means that 52 percent of error in each period will be corrected in long run trend. Also we find that the income elasticity of demand for money is equal to 1.82 which shows that one percent increase in income, lead to 1.82 percent increase in money demand. The positive income elasticity of demand for money is consistent with related economic theories. Moreover the coefficients of rate of return on long-term deposit and real exchange rate equals -0.82 and -0.34 respectively, which shows that one unit increase in return rate on long-term deposit and one percent increase in real exchange rate, leads to -0.82 unit and -0.34 percent decrease in money demand that show substitution of money in Iran is confirmed. Finaly results showed that money demand function during this period was stable.

Keywords

Money Demand Function; error correction model; cointegration; Stability