Monetary targeting and controllability of money supply : an empirical assessment for Sri Lanka

Assessing the degree of controllability of money supply IS an important issue when monetary aggregates are the target of monetary policy. This study is an empirical investigation of the question what degree do central banks have controllability over money supply? in the particular case of Sri Lanka. The question is addressed using two different approaches. The first is the conventional money multiplier approach and the second is the post-Keynesian contention that the money supply is endogenously determined. In conventional money supply approach, the controllability of money supply is assured if the money multiplier is sufficiently stable and monetary base is exogenous. The endogenous money hypothesis emphasizes the ability of financial system as a whole to generate monetary liabilities apart from the central bank's monetary stance. Thus the core of the endogeneity hypothesis that bank credit cause broad money is tested. The findings indicate instability in the broad money multiplier, with the endogenous money hypothesis shedding light on why it is unstable.