The Impact of Financial Innovation on the Money Demand Function: An Empirical Verification in India

Abstract

Traditional money demand functions are often criticized for persistent over-prediction, implausible parameter estimates, highly serially correlated errors and unstable money demand. This study argues that some of these problems may have emerged for the lack of factoring financial innovation into the money demand function. This study estimates money demand for India during the post-reform period, from 1996:Q2 to 2016:Q3. The money demand function is estimated with the linear ARDL approach to cointegration developed by Pesaran, Shin, & Smith (2001), Bounds testing approaches to the analysis of level relationships, Journal of Applied Econometrics, 16(3), 289–326, after employing various proxies for financial innovation. In conclusion, the study finds that there is a stable long-run relationship among variables, such as real money balances, and the scale and opportunity cost variables. In a nutshell, the study assesses the relative importance of financial innovation variables in the money demand equation, and finds that financial innovation plays a very significant role in the money demand specification and its stability. JEL Classification: E41, E44, E42, E52, O16, O53

Revisiting Money Demand Stability in India: Some Post-reform Evidence (1996–2016)

“…Thus, results on the stability of MDF after structural breaks in the macroeconomic series led by financial innovations in the late 1970s and 1980s are mixed in the case of India in particular and throughout the globe in general. Most of the studies support the view that money demand is stable even after economic reforms (e.g., Adil et al, 2020;Arora and Osatieraghi, 2016;Muralikrishna Bharadwaj & Pandit, 2010;Padhan, 2011 in case of India). Conversely, some studies support unstable money demand after reform (e.g., Aggarwal, 2016;Singh & Pandey, 2010 in case of India).…”

“…The study concludes that the inclusion of financial liberalisation in the model plays a key role in determining MDF and its fluctuations. Adil et al (2020) argue that criticism, such as persistent over prediction, implausible parameter estimates and highly serially correlated errors are made about MDF just because of the lack of factoring financial innovation into MDF. They estimated MDF with the help of the ARDL cointegration approach by incorporating various proxies for financial innovation.…”

Economic Policy Uncertainty and Financial Innovation: Is There Any Affiliation?

“…They suggested that financial innovation induces people to move from liquidating currency to electronic currency in their daily transactions, and thus the state of money supply falls, leading to disruption. Further evidence is available in the studies by Dooley and Spinelli (1989), Arrau and De Gregorio (1993), Arrau et al (1995), Hafer and Kutan (2003), Adil et al (2020), and Dlamini and Mabuza (2020). Existing literature advocates that financial innovation not only plays a critical role in money demand functions but also assists in achieving transactional efficiency in the financial sector as a result of the adaption and evolvement of innovative financial services in the financial system.…”

Dampak E-Money Dan Dimensi Transaksi Terhadap Permintaan Uang Di Indonesia

“…Dengan mengetahui jumlah uang yang diminta oleh masyarakat Indonesia maka dapat membantu Bank Indonesia sebagai otoritas moneter dalam mengendalikan peredaran uang di masyarakat. Kegagalan dalam menciptakan permintaan uang yang stabil dimungkinkan karena mengabaikan peran inovasi finansial (Adil et al, 2020). Seiring dengan perkembangan teknologi dan informasi, sistem pembayaran yang digunakan sebagai alat tukar dalam aktivitas perekonomian mengalami perubahan.…”