Abstract:
After an upward trend for about 25 years, the income velocity of money in South Africa reversed its course in 1994 and began a steep decline that continues to the present day. Some writers have argued that the change in income velocity is symptomatic of an unstable demand for money. The implication of this argument being that movements in the money supply provide little useful information about medium-to-long-term inflationary developments. We argue otherwise. Our basic premise is that there is a stable demand-for-money function but that the models that have been used to estimate South African money demand are not well specified because they do not include a measure of wealth. Using two empirical methodologies--a co-integrated vector equilibrium correction approach and a time-varying coefficient approach--we find that a demand-for-money function that includes wealth is stable. Consequently, our results suggest that the present practice of the South African Reserve Bank whereby M3 is used as an information variable in the Bank's inflation-targeting framework is well placed. Copyright 2009 The author 2008. Published by Oxford University Press on behalf of the Centre for the Study of African Economies. All rights reserved. For permissions, please email: journals.permissions@oxfordjournals.org, Oxford University Press.
Journal of African Economies is edited by Marcel Fafchamps
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