Money demand function: a heterogeneous panel application

Abstract

An aggregate data panel is constructed for the GCC's six countries and the cointegration hypothesis among the variables of the money demand function is verified using Pedroni's heterogeneous panel cointegration tests. The idiosyncratic, panel and group-mean cointegrating vectors are then estimated using FMOLS and a modified version of FMOLS developed by Pedroni. The idiosyncratic elasticities have the expected signs in general but are significant only in the case of the scale variable. However, when the power of the test is increased, and allowance made for heterogeneous cointegrating vectors, the group-mean estimator shows a significant negative semi-elasticity of money demand with respect to interest rate.

Acknowledgements

The author thanks Peter Pedroni, Mouawiya Alawad, Husni Charif and participants at the Canadian Economics Association conference in Ottawa (May 2003) for helpful comments.

Notes

 The banks list and data are available from the author upon request.

 This figure may slightly underestimate the reality because some conventional banks offer some Islamic banking services. However, no detailed data are available.

 The only exception is Kuwait, which used to fix its currency to SDR until January 2003.