Stability Of Money Demand In A Developing Economy: Empirical Evidence From South Africa

Abstract

A stable money demand function plays a vital role in the analysis of macroeconomics, especially in the planning and implementation of monetary policy. When investigating the theory of money demand, there are some important issues that need to be considered, such as the choice of the appropriate measure of money, the scale variable (income or wealth) and the opportunity cost variable (short- or long-term interest rates). This paper estimates a stable long-run equilibrium relationship between real money demand (RM2) and its explanatory variables in South Africa, using cointegration and error correction methods. The results obtained confirm the existence of such stable equilibrium relationships. The crucial results from the Error Correction model (ECM) indicate that monetary policy in South Africa is effective. However, in spite of its efficiency, monetary policy does not have a quick effect, needing at least four quarters (one year) from its inception to make a real difference. In other words, there might be difficulties in implementing monetary policy in an emergency situation. Policy implications and suggestions for future research are made in the paper.