Demand for Money in Nepal: An ARDL Bounds Testing Approach

Abstract

This paper investigates the demand for money in Nepal using the Autoregressive Distributed Lag (ARDL) approach for the period of 1975-2011.The results based on the bounds testing procedure reveal that there exist the cointegration among the real money aggregates (M^r₁ and M^r₂ ), real income, inflation and interest rate. The real income elasticity coefficient is found to be positive and the inflation coefficient is negative. The interest rate coefficient is negative for both of the real monetary aggregates supporting the theoretical explanation. In addition, the error correction models suggest that the deviations from the long-run equilibrium are short-lived in M^r₁ than M^r₂ . Finally, the CUSUM and CUSUMSQ tests reveal that the M^r₁ money demand function is stable, but M^r₂ money demand function is not stable implying that the monetary policy should pay more attention to M^r₁ than M^r₂ .