The Demand for Simple-sum and Divisia Monetary Aggregates for Pakistan: A Cointegration Approach

Abstract

Financial liberalisation and the advance of financial innovation in a number of developed economies has been blamed for the break-down in the demand for money based on simple sum measures. This break-down has prompted research into Divisia measures of the demand for money. Like many developing countries, Pakistan is going through a period of financial deregulation which goes hand in hand with financial innovation due to increased competition in the banking industry. This paper employs the methodology of cointegration to compare simple-sum and Divisia level estimates of the demand for money for Pakistan for the period 1974Q4 to 1992Q4. Simple sum measures of M1 and M2 were compared with Divisia versions. The paper reports little evidence in support of the superiority of the Divisia monetary aggregates. Both types of measure produce a stable demand for money and perform satisfactorily in post-sample stability tests, although the Divisia measure appears to perform marginally better on conventional statistical criteria. However, our conclusions have to be qualified by the limitations of the data and the knowledge that the period of financial innovation and deregulation has been relatively recent. The policy significance of the results suggests that currently there is no advantage from switching from simple-sum to Divisia aggregates at the existing level of official aggregation as the proper indicator of monetary policy. However, if financial deregulation and innovation continues at the current pace, the Divisia aggregates may in future prove to be the better indicator.

Three Attempts at Inflation Forecasting in Pakistan

“…Most empirical studies find standard economic relationships to hold. Estimates of money demand functions mostly find money demand to be determined by measures of opportunity costs and activity [e.g., Tariq, et al (1997)]. Likewise, inflation is influenced by changes in money supply, interest rates, measures of aggregate demand or output, and import prices [e.g., Ahmad and Ali (1999)].…”

Constructing Divisia Monetary Aggregates for Nigeria

“…Thus, concluding that monetary targeting in Malaysia could still be used in promoting the effectiveness of monetary policy. Tariq and Matthews (1997) used cointegration approach to analyse the demand for simple sum and Divisia monetary aggregates for Pakistan from 1974:Q4 to 1992:Q4 by comparing simple sum M1 and M2 with Divisia estimates. Though both measures produced a consistent demand for money and scored well in post-sample stability tests, the Divisia measure appeared to perform somewhat better on conventional statistical criteria, according to the data.…”

A Semi-Nonparametric Approach to the Demand for Money in Pakistan

“…In Pakistan, very few studies have focused on the microeconomic foundations of the demand for money. The only relevant study is Tariq and Matthews (1997), which is confined to a comparison of simple-sum and Divisia aggregates. Although the authors do not find significant differences between the two, they argue that, if financial innovations continue, Divisia aggregates will prove far superior in the future.…”