The Role of Bilateral Real Exchange Rates in Demand for Real Money Balances in Cameroon

Abstract

This paper examines the demand for real M2 in Cameroon. After providing a sketch of the development in money demand theories, the paper specifies and estimates long-and short-run demand functions for real M2 using co-integration and error correction techniques. Some emphasis is echoed on the role of bilateral real exchange rates in the demand for real balances. The paper determines the speed that the market may take to eliminate exogenous shocks on real M2. Domestic real income, foreign interest rates, degree of credit restraint and bilateral real exchange rates (BRERs) appear to significantly influence the demand for real money balances in Cameroon. BRERs have both income and substitution effects on money demand and the ultimate effect depends on the dominance of one over the other. The magnitudes of the income elasticity of the demand for money suggest that wealth holders in CFA denominated assets consider money as a normal good. Some policy implications were derived from the analysis (JEL:E41).