Estimating the money demand function for Saudi Arabia using divisia monetary aggregate

ABSTRACT

This paper constructs the broader Divisia monetary aggregate (D2) for the Kingdom of Saudi Arabia over the period from 1999 to 2018. Unlike the traditional money supply aggregate (M2), movements of the Divisia monetary aggregate seems to reflect the domestic economic developments and hence can be very useful when setting macroeconomic policies in the Kingdom. In addition, the paper applies the Keynesian Money Demand Theory to estimate the demand for money using the Divisia monetary aggregate. The findings confirm the stability of the money demand function for Saudi Arabia.

KEYWORDS:

• Divisia monetary aggregate
• stability
• ardl
• cointegration

Disclosure statement

No potential conflict of interest was reported by the authors.

Notes

¹ The name of Simple-Sum money supply is derived from the fact that all components within the monetary aggregate are simply ‘summed up’ together. In notations, the simple-sum monetary aggregate (${\mathrm{S}}_{\mathrm{t}}$) is defined as ${\mathrm{S}}_{\mathrm{t}}=\sum _{\mathrm{i}=1}^{\mathrm{N}}{\mathrm{m}}_{\mathrm{i}\mathrm{t}}$, where ${\mathrm{m}}_{\mathrm{i}\mathrm{t}}$ is the monetary component $\mathrm{i}$ at time $\mathrm{t}$.

² Monetary and financial statistics: compilation guide – Washington, D.C.: International Monetary Fund, 2008. ISBN 978-1-58,906-584-0 (Link).:

³ See, for example, Wesche (1997), Darvas (2015), Ishida (1984), Khainga (2014), and Belongia and Ireland (2019).

⁴ See Alkhareif and Barnett (2012), Barnett and Alkhareif (2013), and 2015a) for more details.

⁵ In practice, one can choose the maximum interest rate in the universe of all assets in each period. In the case of Saudi Arabia, we use all available information of market interest rates, including on SAMA bills, interbank rates, and other domestic market rates.

⁶ The continuous time Divisia index is not presented here for simplicity reasons. Similarly, discussion on estimating aggregator functions is beyond this paper to ensure that our results do not entail any estimations that could lead to biased estimates.

⁷ For more details, see the 2017 Article IV Consultation Report for Saudi Arabia by the International Monetary Fund: (Link).

⁸ See Banafea 2012 for more details.

⁹ Based on Keynes’ approach, people demand money for transaction, precautionary, or speculative reasons. For the first two reasons, most people tend to demand money for transaction or cautionary reasons leading to higher demand for money implying the positive relationship between income and money demand. For the third reason, people prefer holding financial assets rather than money notably with higher interest rate, and vice versa implying the negative relationship between money demand and interest rate.

¹⁰ This paper applies the traditional definition of the opportunity cost commonly used in the money demand literature to ensure comparability of results. Other measure of opportunity cost can be investigated in future research.

¹¹ There are many studies estimating the demand for money with reliance on annual data covering various regions including Africa (e.g. Nwude, Offor, and Udeh 2018,; Asiedu et al. 2020), Asia (e.g. Iftekhar, Mamoon, and Hassan 2016; Umaru and Yusuf 2018; Adhikari 2018), Latin America (e.g. Carrera 2012) and Middle East and North Africa (e.g. Harb 2004; Lee, Chang, and Chen 2008; Bahmani 2008; Basher and Fachin (2014), Hamdi et al. 2015, and Alsamara et al. 2017).

¹² Please note that the bound test is based on F statistics (Wald test).

¹³ See Hansen (1992) for more details.