Money demand, financial liberalization and currency substitution in Malaysia

(:hiS study attempts to examine the relationship between money demand and real \ngross domestic product (GDP), interest rate, real effective exchange rate and the fmancial \nliberalization indicator in Malaysia. The ADF unit root test and 10hansen-luselius \nco integration test were utilized to analyze the annual time series data which range from \n1978 to 2007. Then, vector error correlation estimate was used to investigate the impact \nof money demand to the variabley Growth in real GDP level encourages the increase in \nthe demand for Ml, which is consistent with most of the findings of empirical studies \nI \ndone on money demand. Also, the result showed a positive relationship of real effective \nexchange rate demand for money. In other words, currency substitution effect existed in \nthe money demand function. Nevertheless, the interest rate indicates negative impact on \nnarrow money demand. The fluctuation in the short-run interest rate encourages money \nholder to switch to holding other financial assets, which is a better option to gain return \non the money. As for financial liberalization, the relationship between narrow money \ndemand is negative because the financial innovations had change the demand for Ml to \nbroad money. A stable long-run equilibrium relationship exists among the money \ndemand function and variables.