An Analysis of the Demand for Money in Bangladesh : Partial Adjustment and Vector Error Correction (VEC) Approach
This paper examines the determinants of demand for money in Bangladesh using yearly data from 1975-2016. Partial adjustment model and vector error correction model have been used to examine the nature of short run and long run determinants and short run dynamics. Impulse Response Analysis has been performed by giving a shock to real per capita GDP, inflation, real interest rate, degree of monetization and real exchange rate to visualize the duration of their effects on the real narrow money (M1) and real broad money (M2) in Bangladesh. The results of partial adjustment model in the study suggest that only real M1 follows partial adjustment mechanism. Real per capita GDP and degree of monetization have positive effects on money demand in Bangladesh whereas real exchange rate has negative effect on money demand in Bangladesh which implies that the currency substitution effect is less than the asset substitution effect. The Johansen-Juselius procedure is applied to test the co integration relationship between variables and it is followed by the VEC (Vector Error Correction) regression model. The empirical results of the study trace a long-run equilibrium relationship in the variables for real narrow money in Bangladesh.
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