Modeling the demand for money and inflation in Belarus

Abstract

A stable money demand function is an important prerequisite for conducting an effective monetary policy, and therefore for sustainable, balanced growth. Consequently, it is not surprising that many theoretical and empirical studies are devoted to the problems of money demand.128 Many of the empirical studies provide evidence that a stable money demand function exists both in advanced economies and in some developing countries. In such studies modern techniques of econometric analysis are used. They enable the analysis of both the long-run and short-run aspects of economic dynamics. A wide usage of cointegration analysis and equilibrium correction models is characteristic of the research of money demand.129 Until recently the implementation of comprehensive econometric tools for the analysis of money demand in transition economies was practically impossible, due to absence of necessary statistical data and/or too short time series. However, in new publications such tools, including cointegration analysis, are used.130 Obviously, as the length of the available time series expands, the number of such works will increase too. We believe that the topicality of the research on money demand in Belarus is determined by the following. Although the elements of a market economy in the country appeared in the first half of 1990s, subsequent economic policy has turned Belarus into one of the outliers amongst transition economies. Pervasive and intensive government intervention in economic activity substantially blocks market mechanisms and hampers private sector development. Macroeconomic stability and high inflation remain a problem for the Belarusian economy. In such conditions, the analysis of the money demand function allows, on the one hand, to clarify how the demand of monetary balances is formed in a economy with a high degree of state regulation, and how this influences inflation. On the other hand, such analysis provides useful empirical information for effective monetary policy and anti-inflation measures. The main aim of this chapter is to get answers on the following three questions: 1. Does money demand function exist in Belarus over the period 1992-2004 and what are its main determinants are? 2. Is money demand function stable in the long run and short run? 3. Is there empirical evidence of monetary nature of inflation in Belarus? Money demand in this chapter is investigated by means of cointegration analysis and equilibrium correction models. The results of the research should be considered definitely as preliminary and it will be a subject of further analysis, as a longer time series will be available. Nevertheless, we believe that our research will stimulate further studies of the money demand in Belarus. The structure of the chapter is the following. In the second section, we present the theoretical background for the money demand function. In the third section the data used in our analysis are described and their order of integration is determined. In the fourth section the long run money demand functions are investigated both for nominal and real balances. The fifth section presents constancy analysis of cointegration relations reflecting money demand. In the sixth section, the short run equilibrium correction money demand function is estimated. Monetary factors of inflation are analysed in the seventh section. The final section summaries the results of our research and provides conclusions. © Springer Berlin · Heidelberg 2006.