Demand for Money and Exchange Rate: Evidence for Wealth Effect in India

External factors such as variations in exchange rates should, to some extent, affect the composition of optimal money holdings. It was Robert Mundell who proposed the idea that demand for money could depend on the exchange rate in addition to the income and interest rate. Changes in exchange rate may have two effects on the demand for domestic currency, wealth effect and currency substitution effect. The main objective of the paper is to examine the effects of exchange rate on domestic demand for money in India covering the period of 1998Q1 to 2009Q4. The statistical and time series properties of each and every variable are examined using the conventional unit root test and utilizes Johansen-juselius cointegration analysis to test for the existence of a long run relationship between the determinants and the error correction from the long rum money demand is then used. The results shows a little evidence for the basic contention that exchange rates have a significant influence on money demand and increase in exchange rate not results in reduced domestic demand for money in India