FINANCIAL LIBERALIZATION AND THE DEMAND FOR MONEY : EVIDENCE FROM SELECTED ASIAN COUNTRIES

Abstract

The demand for money function is one of the most comprehensively studied economic relationship in macroeconomics given its importance as a critical component in the formulation of the monetary policy. The existence of a predictable and stable money demand function is an important prerequisite for operating a policy framework centered around monetary targets. This thesis attempts to incorporate explicitly the effect of financial liberalization on money demand behaviour in Malaysia, the Philippines, Singapore and South Korea by including "open-economies" variables such as foreign interest rates, expected changes in exchange rate as well as a financial innovations variable in our estimation of the demand for money function. The empirical results, as shown by the Johansen's cointegration test, indicate that a stable long-run relationship exists between monetary aggregates (narrow and broad) and their determinants in these 4 countries. In addition, we managed to obtain stable error-correction models that could withstand a battery of diagnostic tests. This indicates the existence of stable short-run money demand functions in these countries as well in spite of the financial liberalization process that they have experienced.