Determinants of Money Demand Function in Ethiopia

Abstract

In Least developed countries (LDCs) like Ethiopia, one of the major macroeconomic problems is the absence of effective monetary policy. The money demand function play a major role in macroeconomic analysis, especially in selecting appropriate monetary policy actions. The objective of monetary policy in LDCs is usually related to money and credit control, price stabilization and economic growth. Many LDCs considered, price stability as the most important objective of monetary policies and it is important to testing the stability of parameter of money demand function indicate the effectiveness of the conduct of monetary policy. The research to be conducted therefore is to investigate the determinants of money demand function. Based on the data, an error correction model (ECM) will be applied to estimate the money demand function in Ethiopia. From the study it is found that, money demand is positively related with real GDP and it is negatively related with expected inflation and real effective exchange rate. Therefore, the paper recommends that the determinant of money demand which is real GDP, real money balance, inflation rate and real effective exchange rate should be first stabilized in order to have appropriate circulation of money.