Money Demand Function: A Not-So-Fond Farewell in the Light of Financial Development

Abstract

This study investigates the stability issues of real money balances considering financial development. We estimate real narrow (M1) and broad (M3) money demand in India during the post-financial reform, from 1996:Q2 to 2016:Q3. To check the short- and long-run relationships, this study uses the autoregressive distributed lag model of cointegration and other various time series techniques. After incorporating financial development into money demand, we determined short- and long-run relationships and a well-defined open-economy stable money demand specification (M1 and M3) in India. Having established money demand function, the policymaker and central bankers can use monetary aggregates as an indicator or information variable to predict output gaps and inflationary expectations under the inflation-targeting framework.