In the production function (MIPF) 21 2.6 Money in the indirect production function 22 2.7 Derivation of the money demand function in microeconomics 24. Until the 1970s, the money demand function was considered one of the most stable and reliable in economy. .
Key questions and research hypotheses
Objectives and chapter outline
Genocide is undoubtedly the cause of the bimodal shape in the first two variables. iii). The tragedy of the genocide in 1994 is an event that is perhaps beyond our ability to understand or think.
Introduction and chapter outline
From Section 2.9 to Section 2.11, we present the various money demand models that focus on each of Keynes's three motives for holding money. We then synthesize all the theoretical material, in Section 2.12, to provide a justification for the money demand function we estimate in Chapter Four.
Theoretical contributions of researchers on money demand
A shortcoming of the neoclassical approach is that it does not give an explicit role to the interest rate in determining the demand for money in their writings (Sriram, 1999). Therefore, Keynes formally introduces the interest rate into the money demand function which he specifies as md = f(y,i), in which the real money demand balance md depends positively on real income y and negatively on the rate of interest, i.e.
Money In the Utility Function (MIUF)
This approach is often associated with the Chicago School, which views the demand for money as a direct extension of the conventional theory of the demand for any durable good (see Feige and Pearce, 1977). underlying assumptions about money in the utility function. An increase in the average amount of real balances and goods increases the utility of individuals.
Money in the indirect utility function
In this model, shopping time has negative marginal utility because it reduces time for leisure. One proportional form of the shopping time function weighted by consumption is: . nVc^Wc) &.
Money In the Production Function (MIPF)
In fact, it is assumed that if a company does not maintain real balance sheets, it will experience problems paying its employees, suppliers and selling its output, as it "would have to divert part of its labor and capital to somehow provide for payments and revenues directly into raw materials, where such diversion reduces the amounts of labor and capital allocated to the production of output, thereby reducing the company's output" (Handa, 2000: 63). Therefore, in a monetary economy where goods are exchanged for money, real balances are considered an input into the production function with higher real balances leading to higher output because the firm does not need to divert labor and capital to handle the payment and receipt process.
Money in the indirect production function
If the firm had a small amount of money, it would still have to assign certain workers to handle purchases and sales. Having n means that the firm's total employment is composed of the labor directly involved in production «, and workers carrying out transactions n2, so that.
The derivation of the money demand function in microeconomics .1 The derivation of an individual's demand for money and other goods
Deriving the firm's demand for money and for other goods
Having derived the household demand for money, we now turn to the derivation of the firm's demand for money and other goods. IT is the company's profit, pkF\n,K,mf) is the company's total revenue, Wn is the wage bill, pK.
Deriving aggregate demand for money
The determinants of the demand for real money in (42) can be divided into two broad categories: (i) one part representing income or wealth, and (ii) the other part representing the opportunity cost of holding money rather than its alternatives. It should be emphasized that our specification of money demand in Chapter Four has elements of equation (42) in that it includes a variable that captures all prices, another for real GDP, and a variable that attempts to capture the opportunity cost of holding money.
The aggregate demand for money: a simplification for macroeconomic models
Furthermore, economists rarely want to study the interaction between the demand for money and the supply of labor, but rather focus on national income in the macroeconomy. This specification means that the demand for real balances in the economy depends on the user cost of physical capital (r - n), the user cost of holding money (r - rm), real labor income y and the real value of capital . initial power °/p.
The transactions demand for money
Baumol's application of the basic inventory analysis to the transactions demand for money
At the beginning of the period, the individual has available income F in the form of bonds B and money M. In this figure, the solid line (main diagonal) from F to 1 (on the horizontal axis) represents the remaining amount of income available to the individual at different time periods.
Issues about holding currency or demand deposits
It is important that our estimate of the long-run money demand in Rwanda, detailed in Section 4.2, finds that the interest rate plays no role and the elasticity of money demand with respect to real income is 0.596 which is close to the implied one. theoretical level. Thus, the general conclusions of the Baumol model remain intact, since "in the aggregate, the demand for real transaction balances increases less than proportionally with real expenditure, falls with the return on alternative assets; and does not change if all prices change proportionally" (Handa, 2000: 97).
The speculative demand for money .1 Keynes' speculative demand for money
Formalization of Keynes' speculative demand for money by Tobin
Tobin (1958) hypothesizes that an individual chooses to hold money as part of a portfolio because the rate of return on holding money is more certain than the rate of return on holding profitable assets. If we assume that r is the current yield on consoles or the coupon payment and consider re as the future expected market rate of return on consoles as the expected discount rate, then Pb.
The precautionary demand for money
Thus, the individual's demand for money appears to be the discontinuous step function (AB, CW). Models of the prudent demand for money assume uncertainty about income and expenditure in the future.
Theoretical underpinning of the money demand specification to be used in our empirical chapter
The salient feature of equations (55) and (56) is that the demand for money is a demand for real balances. He bases his analysis of the demand for money on the decision-making process of individuals and derives the so-called liquidity preference function, in which the demand for real balances is negatively related to the interest rate and positively to real income.
Summary and conclusion
These are rather strict conditions and money is not neutral in the short term (Mankiw, 1999). Keynes introduced the speculative demand for money into the literature, claiming that it arose from uncertainty about the future of the interest rate; this led to Keynes's so-called measure of liquidity preference.
Introduction
Overview of monetary reforms in Rwanda
The implementation of the Poverty Reduction Strategy in Rwanda is guided by the following key principles, among others: The crucial role of the private sector as the motor of economic development of Rwanda has been made clear.
The monetary policy adopted in Rwanda, before the implementation of the structural adjustment reforms
Control of the demand for credit by the National Bank of Rwanda
- Modification of banks' conditions
- Adjustment of the rediscount rate
On the one hand, the interest rates that the central bank applied to the commercial banks with regard to rediscounting were an essential part of the structure of interest rates. Different rediscount rates were therefore applied, differentiated according to the nature of the transactions initiated by the commercial banks concerned and according to the sector requiring refinancing.
Control of the supply of credit by the National Bank of Rwanda
- Control of the level of commercial banks' free reserves
- Credit Extension Ceilings
- Thorough credit control
- Judicious control of financial intermediation
Consequently, the NBR had to revise upwards the total amount it was willing to extend to commercial banks. One problem that arose is that the NBR did not carry out inspections of commercial banks on a regular basis.
Shortcomings and weaknesses of monetary policy before structural adjustment reforms
The advent of the structural reforms in 1990
The main financial reforms of the 1990's
With the abolition of the procedure for provisional permits, the NBR's control of the banks fell out of use and was replaced by an ex post supervision carried out under the auspices of the NBR. In the context of economic and financial liberalization based on market forces, the NBR's financing of state activities could not continue.
The indirect character of current monetary policy in Rwanda
- Inflation targeting in Rwanda
- Procedures for controlling the monetary stock
The NBR uses the following linear relationship between M2 and H (the monetary base): M2 — bH2, where b is the monetary base multiplier. Treasury bills are auctioned weekly and the auction is conducted by the NBR on behalf of the government.
Persistent obstacles to the conduct of judicious monetary policy in Rwanda
Furthermore, most of the instruments of indirect monetary policy are market-based, so markets must operate efficiently for policy to be effective (Musinguzi and Katarikawe, 2001: 22). In addition, some existing commercial banks prefer to keep most of their free reserves with the NBR, adding another constraint to monetary policy.
Conclusion
The effectiveness of the Rwandan indirect monetary policy has been undermined by a number of factors:. i) Foreign exchange flows are difficult to predict and they affect all other forecasts, including base money that the NBR uses in its decision making. It is difficult to predict real GDP growth given the informal nature of the Rwandan economy.
Introduction to stability
One reason for finding volatility is that most empirical work uses the partial adjustment model as a specification for the money demand function (Beguna et al., 2002). In the following sections, we first estimate the stability of the money demand function in Rwanda using the M2 definition of money.
Model specification
In Section 4.4 we estimate the long-run money demand equation in Rwanda using the modern approach of cointegration analysis. Nell (2003) also follows Hendry and Ericsson (1991b) to test for weak and super exogeneity of money and prices through the M3 money demand function in order to determine whether money contains important information about future price changes. in South Africa.
Data analysis and checking variables for stationarity
Checking variables for stationarity
- Graphical analysis
- Sample correlogram
In Figure 4.3, the logarithm of real GDP tends to decline until 1994 when it starts to become fairly horizontal. The interest rate differential in Figure 4.4 does not show any particular trend, as it is quite variable.
M2 (Ins)
P (Ins)
Y (Ins)
The Augmented Dickey-Fuller (ADF) unit root test
That is, we accept the null hypothesis that 8 = 0 (that is, p = 1) and there is a unit root; the time series in question are not stationary. Compared to the plots of the original variables (see Figures 4.1 to 4.4), the plots of the transformed time series show no trend and appear constant in their mean, variance, and covariance.
The income velocity of money
The graph shows that VMl is the logarithm of the velocity of income of Ml (currency plus demand deposit), VQM is the logarithm of the velocity of income of quasi-money (various time deposits) and VM2 is the logarithm of the velocity of income of M2 (Ml plus quasi-money) all seem to be going down despite the break trends in 1994 during the Rwandan war and genocide. The graphs show that the trend of M2 is influenced by the behavior of its subcomponents VQM and VMl.
Cointegration and long-run money demand estimates
Furthermore, Inder (1993) demonstrates that the exclusion of dynamics in finite samples can affect the efficiency of the estimator and proposes as an alternative the Unconstrained Error Correction Model (UECM), which should reduce bias and also include dynamics in the estimation of the long-run model. However, there are differences between the magnitude of the coefficients in Equation (4) compared to Equation (7).
Short-run dynamic Error Correction Model
Therefore, the rate of adjustment of money demand in Rwanda is equal to 0.12, which is considered low, indicating the slow adjustment of the quantity of money demanded towards its long-run equilibrium value. The model actually fits the data quite well for years of war and genocide.
Testing for stability of the money demand function
- Recursive Least Squares (RLS) Coefficients
- One-Step Recursive Residuals
- Scaled Recursive Chow Test
- Tests for exogeneity
Plots of the recursive least squares coefficients of our ECM are shown in Figure 4.15 below. To allow comparison, we present below the one-step residuals of the marginal processes of Ap and Ay.
Conclusion and summary of the main empirical results and their policy implications
Recall that a variable is said to be super-exogenous to the parameters of interest if it is weakly exogenous to the parameters of interest, and also invariant to changes in the parameters of the marginal model (Hendry, 1995). In our investigation of superexogenity, we found that prices and income were weakly exogenous and the parameters of our conditional model were invariant to changes in the parameters of the marginal process leading to the conclusion that prices and income are superexogenous.
Introduction
Research hypotheses
Conclusion and future research
Evidence on the Demand for Money: Theoretical and Empirical Results, in Currency Issues in Monetary Theory and Policy, ed. A review of the demand for money literature: theoretical and empirical work with a special focus on error correction models.
