Abstract:
The relationship between real money demand and its determinant is ambiguous, both
theoretically and empirically. Hence, the study's main objective is to determine factors
affecting real money demand and its stability in Ethiopia. Using annual time series data from
1991 to 2021, the study employed the autoregressive distributed lag model. This model
demonstrates that the series have a long-run relationship during the study period. According
to the Zivot-Andrews and the Clemente-Montanes-Reyes unit root test, some of the variables
under study are stationary at the level, while others become stationary after the first
differencing. The empirical results reveal that all of the variables studied had a statistically
significant impact on real money demand in both the long-run and short-run. More
specifically, the long-run and short-run coefficients of Real GDP are statistically significant
at a 1% level of significance; implying a 1% rise in the real GDP corresponds to a 0.34
percent increase in the real money demand in both the short run and the long run.
Furthermore, the domestic interest rate and the real effective exchange rate are statistically
significant at a 1% level of significance in the long-run. Generally, in the long run, a 1%
increase in real GDP, domestic interest rate, real effective exchange rate, Treasury bill rate,
and budget deficit in Ethiopia affect real money demand by 0.34 percent, 34.51 percent, 1.5
percent, 17.42 percent, and 0.05 percent, respectively. The CUSUM is significant and does
not cross to the critical line and then further clarified by CUSUMQ implying the stable real
money demand is obtained. The Toda-Yamamoto Granger causality results revealed a
bidirectional causal relationship between real GDP and TBR with feedback effect, as well as
a unidirectional direction of causality and no causation among the remaining variables. As a
result of the findings, more focus should be placed on productivity and efficiency of
government expenditure and monetary authorities can make policy decisions with better
confidence regarding their impact on macroeconomic variables
