Demand for money plays a major role in macroeconomic analysis, especially in selecting appropriate monetary policy actions. Consequently a steady stream of theoretical and empirical research has been carried out world-wide over the past several decades. The interest on developing countries has heightened in recent years, triggered primarily by the concern among central banks and researchers on the impact of the movement toward the flexible exchange rate regime, globalization of capital markets, ongoing domestic financial liberalization and innovation and country specific issues. The permanent need to search for a model of the demand for money which to be both theoretically coherent, empirically stable (in the sense that the parameters of a given specification would not change significantly over time) and robust (in the sense that a different search procedure or a different sample period would not substantially alter the selected specification) is one of the most important issues in macroeconomic policy. It is central for the elaboration of any general macroeconomic model and especially to the transmission mechanism of monetary policy. (Cuthbertson and Taylor 1987). The origins of this search can be found in Milton Friedman’s paper “Optimum Quantity of Money – A Restatement” (1956) which has marked the beginning of an assiduous search for a money demand function definition by many economists, search that continues even today. The reason for this continuous search of an estimated demand for money function is that if a stable demand function containing a limited number of explanatory variables exists, policy actions which alter the money stock can be expected eventually to have predictable effects on ultimate target variables.
Therefore, the knowledge of a stable demand function decreases the outcome uncertainty of monetary and fiscal policy. In other words, the stability of the demand for money function means that the demanded quantity of money is predictable related to a small set of variables linking money to the real sector of the economy.
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