Sectoral analysis of the demand for real money balances in Pakistan

Abstract

The paper attempts to investigate sectoral-household, business, and aggregate-behaviour of money demand in Pakistan by employing unit roots, cointegration, and error correction mechanism (ECM) methodology. Univariate analysis indicates that all the series used in the analysis are non-stationary. Further analysis reveals that there is a long-run relationship between the real money demand and its determinants in both sectors. Estimated long-run relationship reveals that there are substantial differences between the determinants of money demand and their estimated elasticities between the two sectors. First, the long-run real income elasticity of money by the personal sector is less than what is obtained for the business sector's sales elasticity of money demand. Another difference between the two sectors is in the appropriateness of interest rate. The business sector seems to have responded the rate of interest on bank advances whereas individuals are more influenced by the long-term interest rates represented by the bond yield. The magnitude of own interest rate elasticity of money balances is another important difference across the sectors. The rate of inflation is important in the determination of money demand behaviour for all the sectors. However, the impact of the rate of inflation on the money demand behaviour is different across the sectors. The household sector is more sensitive to the rate of inflation in the short-run as well as in the long-run than the business sector.