Abstract:
This study attempted to empirically investigate the economic reform and stability of real money demand in Ethiopia using time series data over the period 1980-2022. The data was collected from ministry of finance (MOF) and National Bank of Ethiopia (NBE) database. It employed the Autoregressive Distributive Lag (ARDL) bounds test approach for cointegration and vector error correction model (VECM) based granger causality test technique for causality analysis. The ADF procedure is used in order to identify whether the variables have stationary or not.As a result, all variables are fixed the stationarity problems within a combination at their level and first order difference. The empirical results suggested the existence of long run relationship between the economic reforms and determinants of money demand stability.The findings also provided evidences for bidirectional causality links running between real money demand, opportunity costs of holding money (inflation and exchange rates) and economic reforms (real GDP) which in turn, a key factors to determine stability of money demand. The results imply that improve in real economy positively stabilized demand for money. While upsurge in inflation and exchange rates are destabilized demand for money, subsequently reduced the purchasing powers. The error adjustment term (ECT-1) is significant and has a negative sign. This implies that real money demand reacts to any long-run disequilibrium which will be adjusted by half a year.On the other hand, structural stability in real money demand functionis basicallyquestionable. This unpredictability can be caused by development needs in the economy.Thus, the monetary authorities should not only consider economic reforms but basic monetary policy parameter adjustments that have a direct link with economic reforms. Such as by modifying the nominal base rate to combat inflation, expanding the financial sector by increasing access to financial services, and sterilizing the structural liquidity traps to establish stable long run money demand functionsand should be emphasized other monetary policy option rather than aggregate monetary approach to stabilize real money balances
