An Estimation of Money Demand Function in Pakistan: Bound Testing Approach to Co-integration

Money demand function plays a vital role in monetary policy formulation. The present study is an attempt to estimate the factors which determine real money demand function in Pakistan. The study is based on a time series data analysis covering the period from 1972 to 2011. We have employed a bound testing approach to cointegration for estimating money demand function through an auto regressive distributed lag (ARDL) frame work. Findings of the study reveal that variables like real GDP, financial innovation and total population have positive effects on real demand for money while factors like deposit and exchange rates are inversely related to real demand for money. Furthermore, it has been observed that error correction term is highly significant and shows high rate of convergence to the equilibrium. The study bears a policy implication for monetary authorities in Pakistan to adopt a liberal stance on monetary policy for boosting economic and business activities in the economy