A Revisit to an Open Economy Analysis and the Demand for Money Stability: A Case of India

Abstract

The stability for Demand for Money (DFM hereafter) functional form has been a hot topic amongst Monetarists and Keynesian economists since the 1970s. Numerous studies have since been in search of the proper estimates of the DFM function and its determinants. This paper is a revisit of Kulkarni-Yuan (2006) paper, “Demand for Money in an Open Economy Setting: A Case of Indiaâ€. It will compare K-Y Vector Error Correction Model (VECM hereafter) regression model for a closed and open economy using 12 years of additional data up to 2016, to new VECM regressions using data spanning for 48 years. With over half the data now available under an open economy setting, we should see an open economy model being the appropriate model to apply to India’s open economy. After running the regressions, we observe that our findings are consistent with traditional Monetarist theory where real GDP being the most significant determinant of demand for money, and interest rate and other variables have little lower effect than GDP. In case of India, this is quite consistent with expectations because interest rates are not inherently very flexible.