Open Economy Demand for Money in Pakistan

Abstract

We examine the determinants of open economy demand for money in Pakistan using Johansen-Juselius co-integration approach and vector error correction model. It focuses upon current float exchange rate regime and quarterly data from 2001Q1 to 2010Q2. The results based on estimation procedure that uses four lags indicate that although M1 is co-integrated with income and interest rate yet the estimate of interest rate is wrongly signed in the co-integrating vector. Adding nominal effective exchange rate in the estimation procedure provides evidence of one co-integrating vector and correctly signed parameters in co-integrating space. The positive estimate of nominal effective exchange rate has implication that monetary authorities should consider nominal exchange rate as valid determinant of M1 If it is used for monetary targeting.