Modeling Demand for Money in Pakistan: An ARDL Approach

Muhammad Asad, Shabib Haider Syed and Ijaz Hussain

Abstract

In this study we have estimated demand for money (M2) function in Pakistan, over the period of 1980 Q1 to 2009 Q2, using ARDL method. The study corroborate support for the hypothesis of long-run equilibrium relationship
between real money demand and a set of variables including real GDP, inflation, rate of interest, real effective exchange rate and foreign rate of interest. The result of F-test and negative sign of EC(-1) term, both suggest
the presence of cointegration. The results are further approved by CUSUM and CUSUMSQ tests. The study concludes that the use of monetary policy could be effective in Pakistan because there is a stable long-run equilibrium relationship between money demand and the set of aforementioned variables. Inflation has a large impact on the demand for money in Pakistan, indicating towards the tendency of agents to hedge in physical assets.