Money Preference Theory

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REVISITING THE STABILITY OF MONEY DEMAND FUNCTION IN PAKISTAN Ihtisham ul Haq1, Shujin Zhu1, S. K. Naradda Gamage1*, Adamu Tijjani Musa1 Abstract This empirical study was carried out to test the stability of aggregate money demand function in Pakistan. The economic theory suggests that income and inflation is positively related to money demand while rate of interest has an inverse relation with it. The autoregressive distributed lag model (ARDL) was applied and it confirmed the long run relation between the studied variables. The coefficients of income, rate of interest and inflation have statistically significant impact on money demand. All the three exploratory variables have expected sign as proposed by the economic theory. The causal…show more content…
This theory postulates that there are three motives; transaction, precautionary and speculative demand for money through which money is being held. Laidler (1977) argued that speculative demand for money is the important pillar of Keynes’ liquidity preference theory. This theory posits an inverse relation of rate of interest with demand for money. Furthermore, he stated that Keynes was not interested in demand for money which arises due to income and precautionary motives. Friedman (1956) presented classical theory of money as theory of money demand. He argued that people intentionally hold money to pay for goods and services in future because of its purchasing power. He opposed the Keynesian view of money demand and stated that velocity of money is highly predictable. According to him there is no question on the stability of money demand. Thus money demand function can predict the quantity of money demanded in the…show more content…
Data on these variables was considered from 1960 to 2005. He concluded that correlation analysis confirmed a strong relation between inflation and money growth and recommended that a tight monetary policy may be adopted to curb inflation in Pakistan. Omotor (2010) examined money demand function in Nigeria. Bound test for co-integration was applied for the data covering the time period from 1970 to 2006. Money demand is found stable and have long run relation with real income, rate of interest, exchange rate and inflation. All the coefficients of independent variables were according to economic theory. Azim, et al. (2010) tested the money demand function by applying ARDL co-integration approach in Pakistan. The long run relationship between money demand, income, inflation and exchange rate was confirmed by their results and they concluded that money demand function is stable for the study period 1973-2007. Arize and Nam (2012) analyzed quarterly data from 1973-1 to 2009-4 for selected seven Asian countries. Their results documented that exchange rate has positive effect on money demand and rate of interest is negatively related to it. They concluded that broad money could play an important tool for monetary authorities to get the desired
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