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

作者:Sahadudheen I 刊名: 上传者:刘冬彦

【摘要】Robert Mundell, was the first to propose the idea that the demand for money could depend on the exchange rate. The main reason behind his conjecture was that an appreciation of foreign currency, or a depreciation of domestic currency, would raise the domestic currency value of foreign assets held by domestic residents. If this was perceived by people as an increase in wealth, the demand for domestic currency could rise. However, if the depreciation of domestic currency induces the expectation of further depreciation, the opposite effect would take place with the public deciding to hold more foreign currency and less domestic currency. In this paper, we argue that since exchange rate has a wealth effect, it could have a direct impact on the demand for money in India. The study utilizes Johansen-juselius cointegration analysis to test for the existence of a long run relationship between the determinants. The cointegrating regression considers only the long-run property of the model, and does not deal with the short-run dynamics explicitly. Clearly, a good time series modeling should describe both short-run dynamics and the long-run equilibrium simultaneously. For this, the error correction model is used. Having controlled for the effect of other factors, we found a little evidence for our basic contention that exchange rates have a significant influence on money demand and increase in exchange rate does not result in reduced domestic demand for money in India. The positive effect of exchange rate on M1 indicates that depreciation of domestic money increases the demand for money, which supports the wealth effect argument.


Undergraduate Economic Review Volume 8 | Issue 1 Article 15 2012 Demand for Money and Exchange Rate: Evidence for Wealth Effect in India Sahadudheen I Pondicherry University, India, Recommended Citation I, Sahadudheen (2011) "Demand for Money and Exchange Rate: Evidence for Wealth Effect in India," Undergraduate Economic Review: Vol. 8: Iss. 1, Article 15. Available at: This Article is brought to you for free and open access by the Economics Department at Digital Commons @ IWU. It has been accepted for inclusion in Undergraduate Economic Review by an authorized administrator of Digital Commons @ IWU. For more information, please contact ©Copyright is owned by the author of this document. I: Demand for Money and Exchange Rate: Evidence for Wealth Effect in DEMAND FOR MONEY AND EXCHANGE RATE: EVIDENCE FOR WEALTH EFFECT IN INDIA Sahadudheen I Pondicherry University, India Introduction The identification of demand for money plays a pivotal role in the transmission mechanism of monetary policy and the money demand elasticities have been considered as critical inputs to regulate the conduct of monetary policy. The relationship between the demand for real money and its determinants is the fundamental block of the theories of monetary economics. The exchange rate along with other determinants is gradually emerged as an alternative route through which monetary impulse response can be transm