Assignment 5

Estimating Money Demand Function for Pakistan, Qatar and Turkey

SUBMITTED TO:
Dr. Nasir Iqbal & Dr. Shujaat Farooq

SUBMITTED BY:
Adnan Saqib
(MPhil Econometrics 3rd Semester)

Registration No:
PIDE2019FMPHILETS07

DEPARTMENT OF ECONOMICS & ECONOMETRICS

Pakistan Institute of Development Economics, Islamabad
 Introduction
In monetary economics, the demand for money is the desired holding of financial assets in the
form of money: that is, cash or bank deposits rather than investments. There are five theories
regarding money demand function in which 3 famous theories are shortly defined below.

1. Fisher’s Transactions Approach to Demand for Money:

In his theory of demand for money Fisher and other classical economists laid stress on the
medium of exchange function of money, that is, money as a means of buying goods and services.
All transactions involving purchase of goods, services, raw materials, assets require payment of
money as value of the transaction made.
Equation: MV = PT
Where, M = the quantity of money in circulation V = transactions velocity of circulation
P = Average price T = the total number of transactions.

2. Keynes’ Theory of Demand for Money:

Keynes used the term what he called liquidity preference. How much of his income or resources
will a person hold in the form of ready money (cash or non-interest-paying bank deposits) and
how much will he part with or lend depends upon what Keynes calls his “liquidity preference.”
Liquidity preference means the demand for money to hold or the desire of the public to hold
cash. According to him people hold money for three purposes: Transactive motive, Precautionary
Motive and Speculative Motive.
3. Friedman’s Theory of Demand for Money
Friedman put forward demand for money function which plays an important role in his
restatement of the quantity theory of money and prices. Friedman believes that money demand
function is most important stable function of macroeconomics.
In the assignment money demand function is estimate for the country Pakistan, Turkey and
Qatar.
Literature suggest that nominal interest rate, exchange rate, inflation, and real income affects the
demand for money. For money demand estimation broad money is taken to measure the effect
[ CITATION Osk07 \l 1033 ] & [ CITATION Sha16 \l 1033 ].

The data is taken from the WDI from year 2000 to 2019.
Broad money M2 is taken as dependent variable and interest rate, exchange rate, inflation and
real income is taken as independent variables. The data is estimated through E-views and result
is given below:
Pakistan:

Variables Coefficient t-stat P-value

Interest Rate -0.69 -4.18 0.00058
Exchange Rate -0.63 2.22 0.048
Real Income 0.713 -2.40 0.000
Inflation -0.12 -3.60 0.023
Interpretation: All the variables show significant relationship with money demand, however the
interest rate, exchange rate, inflation show negative relationship with money demand.
Current Scenario of Pakistan: The State Bank of Pakistan (SBP) reduced the policy rate from
13.25pc to 7pc in less than 100 days between March 18 and June 26, 2020. A variety of
concessional funding programs for companies, enterprises and individual bank borrowers have
also been introduced. "Together these monetary interventions have added an estimated Rs1.58
trillion, or around 3.8 pc of GDP, to the cash flow of companies and households," according to
the SBP press release. According to the government's projection, Pakistan's GDP dropped by 0.4
pc in the last fiscal year. But the International Monetary Fund (IMF) and the World Bank predict
a much sharper decline of more than 2 pc. Post-Covid-19 Ehsa's emergency cash disbursements
to the vulnerable and unemployed, concessional and reward product funding, risk-sharing facility
for small and medium-sized enterprises and accelerated tax refunds are also contributing to
economic recovery[ CITATION Moh20 \l 1033 ].

Policy Recommendation for Monetary Policy: The prevailing high level of political uncertainty
as another big downside risk to growth prospects. Political uncertainty is also fueling inflationary
expectations and that, combined with real inflationary pressures, are keeping inflation high. Also,
the second wave of COVID is causing a problem for the business to run on its full capacity
which is a serious concern for the growth and stability for the economy.
Turkey:

Variables Coefficient t-stat P-value

Interest Rate -0.08 -3.60 0.001
Exchange Rate -0.03 -2.40 0.04
Real Income 0.83 2.22 0.02
Inflation -0.12 -4.18 0.00
Coefficient 6.51 4.79 0.004
Result Interpretation: All the variables show significant relationship with money demand,
however the interest rate, exchange rate, inflation show negative relationship with money
demand.
Current Scenario of Turkey: Calls for lower interest rates have become louder as Turkey's
private driven growth has slowed down. The monetary policy faces the challenges of maintaining
external stability and reviving domestic conditions. To determine which goals are most suitable
for monetary policy, one must understand the effects of monetary policy and its transmission
channels to the macro economy. External factors, such as shocks to risk aversion and global
growth have a much stronger impact on economic activity in Turkey[ CITATION Dom19 \l 1033 ].

Policy Recommendation: The increasing tension with Middle Eastern countries is hurting the
economy which need to be eased down because they are boycotting Turkey products which
definitely hurt business in Turkey. The current defense industry growth should be maintained for
stable economic growth.
Qatar:

Variables Coefficient t-stat P-value

Interest Rate -0.49 3.70 0.016
Exchange Rate 0.15 1.94 0.028
Real Income 0.43 2.54 0.041
Inflation -0.21 2.45 0.05
Interpretation: All the variables show significant relationship with money demand, however the
interest rate, inflation show negative relationship with money demand while real income and
exchange rate have positive relationship with broad money.
Current Scenario of Qatar: The monetary authority current goal is to maintain the international
price, i.e. the exchange rate instead of the domestic price level, where the nominal interest rate is
equal to the US federal fund rate, but the rate of inflation is independent. Rising oil prices and
the devaluing US dollar have caused prices to rise and real interest rates to be persistently
negative in the Qatar. Asset price bubbles formed, then burst, causing significant losses. They
could have moderated, or prevented, the effect of the bubble by floating the currency and
stabilizing domestic prices[ CITATION Ben \l 1033 ].
Policy Recommendation: The domestic price level should be maintained not just the exchange
rate and the reliance in the nominal interest rate should be changed to domestic base cause they
are more aware of the scenario than the US.

References
Aazim, M. (2020, 09 28). DAWN. Retrieved from https://www.dawn.com/news/1581919

Bentour, E., & Razzak, W. (n.d.). Real Interest Rates, Bubbles and Monetary Policy in the GCC countries,
Arab Planning Institute - Kuwait, Information Center. IDEAS .

Domac, I., Isiklar, G., & Kandil, M. (2019). On the potential and Limitations of monetary policy in Turkey.
Middle East Development Journal, 2019.

Oskooee , M. B., & Karacal, M. (2007). The demand for money in Turkey and currency. Applied
Economics Letters, 635-642.

Shahid , H., Umbreen , A., & Mamoon, D. (2016). Measuring Money Demand Function in Pakistan.
Munich Personal RePEc Archive.