Testing the stability of money demand function in Lesotho
by Moeti Damane; Lira P. Sekantsi; Senei Solomon Molapo
International Journal of Sustainable Economy (IJSE), Vol. 10, No. 4, 2018

Abstract: This paper adopts the autoregressive distributed lag (ARDL) bounds testing and error correction model (ECM) approach to co-integration to test the stability of demand for real money balances (M2) in Lesotho from 1980 to 2015. The results provide strong evidence for the presence of a stable long run relationship among M2, real gross domestic product (GDP), consumer price index (CPI), real interest rate spread and real exchange rate. The empirical evidence shows that in the long run, real GDP and real exchange rate are positively related to demand for real broad money balances while CPI and real interest rate spread negatively affect the demand for real broad money balances in Lesotho. The short run findings also show that real GDP and the inflation (captured by CPI) positively and negatively affect the demand for real broad money balances in Lesotho, respectively. The income elasticity of real money demand is greater than unity in the long run while it is close to unity in the short run. The implication could be a heightened demand for foreign interest earning assets in the long run due to a lack of suitable alternative domestic financial assets. This necessitates government action to promote an increase in the availability of alternative domestic assets.

Online publication date: Tue, 02-Oct-2018

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