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2017•Global Business ReviewRequires access

Financial Development and Money Demand Function: Cointegration, Causality and Variance Decomposition Analysis for Pakistan

Muhammad Zeeshan Ahad

Open publisher page 11 citations

Abstract

This study has investigated money demand function incorporating financial development, industrial production, income and exchange rate for Pakistan for time span from 1972 to 2012. Bayer–Hanck combined cointegration and Johansen cointegration approaches have been used to test cointegration among variables and vector error correction model (VECM) approach has been applied to explain the direction of causality in the long run and short run. Unit root problem has been tested by augmented Dickey–Fuller (ADF) and Phillips–Perron (PP) unit root tests. The results indicate that feedback effect is found between financial development and money demand. There is a long-run relationship existing among money demand, financial development, income, industrial production and exchange rate. Financial development is the main factor to determine money demand function in both long run and short run.

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What this paper is about

This study has investigated money demand function incorporating financial development, industrial production, income and exchange rate for Pakistan for time span from 1972 to 2012. Bayer–Hanck combined cointegration and Johansen cointegration approaches have been used to test cointegration among variables and vector error correction model (VECM) approach has been applied to explain the direction of causality in the long run and short run. Unit root problem has been tested by augmented Dickey–Fuller (ADF) and Phillips–Perron (PP) unit root tests. The results indicate that feedback effect is found between financial development and money demand. There is a long-run relationship existing among money demand, financial development, income, industrial production and exchange rate. Financial development is the main factor to determine money demand function in both long run and short run.

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OpenAlex reports 11 citations for this work. Citation counts describe recorded attention and do not establish research quality.

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Available abstract

This study has investigated money demand function incorporating financial development, industrial production, income and exchange rate for Pakistan for time span from 1972 to 2012. Bayer–Hanck combined cointegration and Johansen cointegration approaches have been used to test cointegration among variables and vector error correction model (VECM) approach has been applied to explain the direction of causality in the long run and short run. Unit root problem has been tested by augmented Dickey–Fuller (ADF) and Phillips–Perron (PP) unit root tests. The results indicate that feedback effect is found between financial development and money demand. There is a long-run relationship existing among money demand, financial development, income, industrial production and exchange rate. Financial development is the main factor to determine money demand function in both long run and short run.

Key concepts: Cointegration, Economics, Variance decomposition of forecast errors, Econometrics, Short run, Johansen test, Error correction model, Granger causality

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