The Stabililty of Money Demand in Bangladesh: an Econometric Study

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CHAPTER-ONE

1. Introduction:
The money demand is one of the most closely studied relationships in economics. One reason is that the question of the stability of money demand has long been central to issues of monetary theory. However, despite intensive analytical and empirical efforts, there is no general consensus concerning the stability (or instability) of money demand. Existence of a stable money demand is very much important for maintaining monetary stability. Though there are lots of debates in this topic, it is a subject on which macroeconomists can do further research.

Many researchers have estimated money demand stability model for different economies in different points in time. To date, extensive theoretical and empirical research has been conducted in the search for the appropriate variables and functional forms of the stability of money demand both in the context of developed and developing economies. However, there have been a limited number of empirical studies that attempted to investigate the issue in the context of Bangladesh. These studies on the stability of money demand in Bangladesh suffer from flaws in terms of the: (i) adopted econometric estimation techniques; (ii) choice of appropriate variables; and (iii) data coverage, i.e., the time span. Most of the tests have employed standard regression techniques (i.e., ordinary least squares (OLS)) without examining the time series properties of the concerned macroeconomic variables. Since it is highly plausible that some of the time series variables that these studies have used are non-stationary in their levels, and therefore, the standard regression results are questionable.

Considering all these things and understanding the importance of this topic we take an attempt to test the determinants of SMD in Bangladesh. This study is structured as follows: chapter-1 contains introduction and objectives of the study. In chapter-2, we provide a review of the theoretical literature dealing with the determinants of SMD in Bangladesh. In chapter-3, we outline our model and methodology. The results are then analyzed in chapter-4. In chapter-5, we operate some diagnostic tests for validity of obtained results. Finally, we present the conclusion of our study in chapter-6. 1.2What is Stability of Money Demand (SMD)?

Stability of money demand is a core concept of macroeconomic field that draws attention of economist from the very beginning of macroeconomics. Many economist researchers provide different definitions and concept of SMD from their point of view. Here I shall try to provide a simple definition of SMD considering the views given by the former analysis.

According to Milton Friedman (1956) “The quantity theorist accepts the empirical hypothesis that the demand for money is highly stable-more stable than functions such as the consumption function that are offered as alternative key relations.” It was commonly affirmed that money was a function of relatively few variables, including income and interest rate. By the mid-1970s. A consensus seemed to emerge that money demand was indeed one of the more stable relationships in economics, reliable enough to serve as a basis for formulating monetary policy.

Recently, however, several researchers have found evidence that some specifications of money demand have remained stable through events of the 1970 and 1980s. One common conclusion of these studies is that money demand is highly interest sensitive.

However, despite intensive analysis and empirical efforts, there is no general consensus concerning the stability of money demand functions. The stability problem is analyzed in terms of the money demand function, i.e. the relationship between money stocks and a few key macroeconomic variables such as aggregate income, interest rate etc.

1.3 Why this study?

Realizing the importance of the stability of money demand, least developed,...
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