Modelling the Demand for Money Function in Nigeria: Is There Stability?

Abstract

This study adopts the Keyne’s Liquidity Preference and Friedman Restated Hypothetical approaches to formulate

appropriate demand for money models in Nigeria. Data sourced from the Central Bank of Nigeria for the period

1986-2013 were analyzed using the Augmented Dickey Fuller (ADF) and Phillips-Peron (PP) tests for unit root,

Engle-Granger (1987) Co-integration and error correction modeling technique as well as the Chow test of stability.

The unit root test result revealed that only real income, real interest rate, Treasury bill rate and inflation rate were

stationary at levels while others were stationary at first difference. Result further revealed that while income (Y)

enhances the desire to hold money, interest rate (RT) and expected inflation rate (EXINF) impacted negatively on

money demand indicating that during inflationary expectation and periods of lower interest rates, asset holders

switch out of money assets into real assets. Hence, inflationary expectation and interest rate were vital determinants

of asset substitution in Nigeria. Surprisingly, real interest rate and inflation rate fail to significantly explain the

variation in demand for money in Nigeria for the study period. Result of the Friedman restated hypothetical model

showed that increase in return to other money assets such as Savings deposit, Equity and Treasury bill reduces

economic agent’s desire to hold money. The stability test result further revealed that money demand was stable in

Nigeria for the sampled period. Accordingly, to enhance money demand, policies that would increase real money

income, reduce money banks interest rate and returns on other money bank securities, as well as inflation rate while

ensuring macroeconomic stability should be pursued. The study further makes case for the use of interest rate as a

tool for monetary stability at the expense of real rate of interest.