An Econometric Analysis of Demand for Money and its Stability in Tanzania

Abstract. This paper examines the determinants of demand for money and its stability in Tanzania using annual time series data spanning from 1966 to 2015. Economic analysis of the money demand function is facilitated by the Johansen cointegration, vector autoregressive-vector error correction model (VAR-VECM) and variance decomposition with the main objective of analyzing the factors which, in both short run and long run, influence its movements. The study is thought to be significant because the demand for real money balances serves as the core link between the monetary policy and the real sector of the economy. Based on the annual data under the period of study, cointegration results reveal that there is a long-run relationship between real money balances and the explanatory variables namely, real GDP, deposit interest rate, real exchange rate and inflation rate. Consistent with money demand theory, the VECM results show that the demand for real money balances is positively related with scale variable (real GDP) but it responds inversely to opportunity cost of holding money (deposit interest rate and inflation rate). Moreover, results provide evidence that the demand for real money balances and real exchange rate are positively associated. Furthermore, after incorporating the stability tests, the empirical results show that real money demand function is stable over the 1966-2015 period, suggesting that it is possible to use the narrow money aggregate as target of monetary policy in Tanzania.Keywords. Money demand, VAR-VECM model, Stability.JEL. C32, E41, E52