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Maniklal Adhikary and Ritwik Mazumder

The IUP Journal of Applied Economics, 2006, vol. V, issue 1, 69-79

Abstract: This paper estimates both the long run and the short run money demand functions in India over the period 1970-71 to 2002-03 on the basis of appropriate macroeconomic data. A partial stock adjustment principle is used to frame a short run money demand function. The estimated long run as well as short run money demand functions reveal that transaction motive is stronger than the assets motive for holding money. The long run estimates show further that the Indian macro economy does not suffer from money illusion. Second, the inflationary impact of monetary expansion is estimated econometrically. Long run evidence shows that monetary expansion is inflationary, the impact being felt for over a year. Recent experience however reveals that the inflationary impact is felt over a quarter. Third, it examines the relative effectiveness of fiscal policy compared to monetary policy, employing the St. Louis model. Both the non-nested and nested forms of the St. Louis equation support the superiority of narrow money supply over government expenditure in explaining GDP growth. But the Granger causality shows that the causation from GDP to M1 is more pronounced compared to its contrary thereby establishing the transactions motive for holding money. The strong causation from money to prices is also evident from the test of causality.

Date: 2006
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Handle: RePEc:icf:icfjae:v:05:y:2006:i:1:p:69-79