Time series analysis of demand for money in Bangladesh

This study investigates the determinants of demand for money in Bangladesh using annual observations for the period 1974-95. Partial adjustment approach and error correction approach are applied to investigate the nature of short run and long run determinants and short run dynamics. Both real narrow money and real broad money are used for comparison. Exchange rate and degree of monetization are included in the money demand functions with other traditional scale and opportunity cost variables which is the special aspect of the study.;The results of partial adjustment models in the study suggest that both real narrow money and real broad money follow a partial adjustment mechanism. However, actual money stock adjusts to desired stock almost instantly. Real per capita GDP, degree of monetization and real exchange rate have positive effects on money demand in Bangladesh. Conflicting evidence is found regarding the role of interest rate in Bangladesh.;Cointegration tests suggest that real narrow money has equilibrium long run relationship with per capita GDP while real broad money has that relationship with real exchange rate. Error correction modelling suggests that short run dynamics in the real money are significantly affected by the error correction term, i.e., a proportion of the disequilibrium from one period is corrected in the next period. Finally, empirical results of this study undoubtedly establish the superiority of broad money over narrow money in Bangladesh case. Hence the policy maker is advised to target broad money whenever possible.