Interest rate sensitivity of demand for money and effectiveness of monetary policy: fresh evidence from combined cointegration test and ARDL approach

Masudul Hasan Adil (), Rafiq Hussain and Adelajda Matuka
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Masudul Hasan Adil: Indian Institute of Technology (IIT)
Rafiq Hussain: Sultan-ul-Uloom Educational Society (SUES)
Adelajda Matuka: University of Bologna

SN Business & Economics, 2022, vol. 2, issue 7, 1-24

Abstract: Abstract The money demand function (MDF) is an inevitable monetary policy tool utilized to examine the impact of the monetary sector on the real sector. However, financial innovation and institutional changes in the late 1970s and early 80s have affected the money demand stability. Henceforth, less importance has been given to money in the new Keynesian monetary policy framework. In the preceding backdrop, the present study examines money demand stability by highlighting the interest rates sensitivity as an inevitable issue while estimating different monetary aggregates. To this end, we utilize the combined cointegration, autoregressive distributed lag model, and Hansen’s instability test. The study finds cointegration among variables under consideration and a well-specified MDF, implying a stable short-and long-run money demand relationship in India for the period 1996:Q2 to 2016:Q3. Henceforth, the stable money demand has policy implications in terms of focusing monetary aggregate as an essential indicator or information variable to maintain the price stability under India’s current flexible inflation-targeting framework.

Keywords: Combined cointegration; DSGE; New Keynesian; New Monetarists; Monetary policy; ARDL; India; Interest rate sensitivity (search for similar items in EconPapers)
JEL-codes: E4 E41 E52 (search for similar items in EconPapers)
Date: 2022
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DOI: 10.1007/s43546-022-00249-8

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