Determinants of Demand for and Supply of Money in Bangladesh

Abstract

This is an empirical study of demand for and supply of money in Bangladesh. The study covers the period 1976 to 2008. Estimates were obtained for the whole period as well as for the two sub-periods, 1976 to 1990 and 1991 to 2008. Of these two periods, the first period is known as the pre-liberalization period characterized by highly regimented interest rate, while the second period is known as the post­liberalization period that saw greater flexibility in interest rate. While the estimates of the first period showed income as the most dominant variable, the estimates for the second period revealed increasing role of the interest rate, which implied that the money demand function was converging towards the Keynesian specification with the passage of time. Simultaneous estimation of the money demand and money supply function showed that although money supply function was not found to be very significant, it strengthened the demand function and raised the significance of the interest rate. This work specifically studied the issue of structural break using the Chow test, which revealed that there was indeed a structural break between the two periods. The problem of autocorrelation, widely prevalent in time series studies like this, was formally investigated and autocorrelation corrected estimates were presented. The stability of the money demand function was looked into using the techniques of time series econometrics and results showed that although there was short-run instability; stability existed in the long-run. The causality study showed that income Granger caused money supply, which was consistent with growing money supply of the Bangladesh Bank. This study thus provides a comprehensive picture of money demand and money supply in Bangladesh for the period 1976 to 2008.