Money Demand Determinants and Stability in Yemen: An ARDL Approach to Cointegration

Abstract

This paper investigates the determinants and stability of narrow and broad real money demand functions in Yemen. The ARDL bounds testing approach to cointegration and error correction modeling were applied to quarterly data covering the period from 2001Q1 to 2013Q4. The empirical results suggest the existence of long-run relationships between real money balances (M1 and M2), and their determinants including real income, inflation rate, and exchange rate. The elasticity coefficients of the real income and inflation rate bear the predicted positive and negative signs respectively and found to be statistically significant. The dominance of the currency substitution effect is reflected in the negative sign of the elasticity coefficient of exchange rate. In addition, CUSUM and CUSUMSQ tests support the stability of both M1 and M2 models during the estimation period.