Rethinking money demand function in Nigeria using Toda-Yamamoto Approach

Abstract

This study examined the demand for money in Nigeria from 1980 to 2019, employing various techniques of econometric analysis. The study was motivated to determine whether Keynes liquidity preference theory holds in Nigeria and to ascertain whether money demand function is stable in Nigeria. The Augmented Dickey Fuller (ADF) unit root test showed that the variables were stationary at different levels. The test of stability showed that the estimated parameters for the study are stable within the period under study. Thus, money demand function is stable in Nigeria. Considering a year period lag in the estimated money demand function, it was found that there was a positive relationship between money demand and real income during the period of study. It implies that increase in real income (gross domestic product) leads to increase in the demand for money, as predicted by economic theory. The real income (gross domestic product) coefficient is 0.09 which is less than unit and is consistent with the transactions and precautionary theories. However, the inflation rate both at a year and two years period lags had negative signs, and were consistent with a priori expectations. The coefficient of –0.002 and -0.001 respectively showed that the demand for money in Nigeria will decrease by about 0.2% or 0.1% when the inflation rate (at a year or two year lag) rises by 1%. The result indicated that the higher the rate of expected inflation (i.e. higher returns on the alternative assets), ceteris paribus, and the lower is the demand for money in Nigeria. Hence, people would tend to switch to other money alternatives when inflation is anticipated, because they promise higher rates of returns. In the light of the findings, it was recommended that Central Bank of Nigeria should pursue policy aimed at changing the level of income which will influence the demand for money in the same direction.