Factors Affecting Real Money Demand and its Stability in Ethiopia

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