Financial Crises and Money Demand in Jamaica

This paper estimates the money demand function for Jamaica using a Structural co-integrating VAR. This approach provides estimates of the long run structural relations and also reveals the complex short run feedbacks of monetary policy on key macro variables. In recent years Jamaican governments have adopted an inflation targeting framework for policy and have moved towards reliance on interest rates rather than direct money control as the primary instrument. This policy presumes that monetary transmission runs from the interest rate to directly affect the level of output which then feeds into the inflation process. However, in an economy with limited financial sector development interest rate transmission may be more circumspect, having a strong direct affect on money demand which then influences aggregate demand and output and hence inflation. These feedbacks are investigated within the error correction model.. Stability of Money demand is vital for predictable policy, and is investigated using CUSUM tests for parameter stability. The Jamaican financial sector suffered a major crisis in the mid 1990’s, the paper considers whether the stability of money demand was compromised. It is argued that the finding of stable money demand suggests that the specific policy responses may have successfully bolstered confidence and prevented financial implosion.Caribbean, Jamaica, money demand