The Demand for Money in Developing Countries: Assessing the Role of Financial innovation

IMF Working Papers, May 1, 1991

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Traditional specifications of money demand have been commonly plagued by persistent overprediction, implausible parameter estimates, and highly autocorrelated errors.
The paper argues that some of those problems stem from the failure to account for the impact of financial innovation.
Money demand is estimated for ten developing countries employing various proxies for the innovation process.
The study provides an assessment of the relative importance of financial innovation in money demand.
Key finding: financial innovation plays an important role in determining money demand and its fluctuations, and the importance of this role increases with the rate of inflation.

Traditional money demand models frequently exhibit:
- persistent overprediction,
- implausible parameter estimates,
- highly autocorrelated errors.
Accounting for financial innovation reduces these problems and improves money demand estimation.
Financial innovation is an important determinant of money demand and its fluctuations.
The role of financial innovation in money demand grows with the rate of inflation.

Empirical estimation of money demand for ten developing countries.
Use of various proxies for the innovation process to capture financial innovation.
Assessment focuses on the relative importance of the financial innovation variable in money demand specifications.

Subject: Consumption, Currencies, Demand for money, Income, Inflation, Money, National accounts, Prices
Keywords: business money demand, Consumption, Currencies, Demand for money, Income, Inflation, money balance, money decision, money demand function, money demand specification, money holding, opportunity cost, opportunity cost of money, opportunity cost variable, WP