Empirical research regarding money demand relationships has been directed towards the identification of a few key economic variables that determine desired money balances. The typical money demand specification includes real income to represent the budget constraint. and the returns of one or more alternative assets to measure the opportunity cost of holding money. The demand function also includes a lagged dependent variable to approximate the short-run dvnamic adjustments. In addition to identifying the key variables, important consideration has been given to the structural stability of the estimated money demand function since a stable money demand relation is necessary to implement appropriate monetary policy.
While much of the research has centered on money demand in developed countries, this paper focuses instead on money demand in developing countries. In specifying money demand models for developing countries, two aspects require particular attention.
First, most developing countries have a significant non monetized sector. A sector in which money is not used in market transactions. When approximating the budget constraint, care must then be taken to use the appropriate income measure: that is, Income for the monetized sector only. Second, while the recent trend for all countries is towards a more open economy. It is especially important to consider the external influences of the world economy on developing countries. Many of these countries are relatively small in size and are closely tied to the larger. More developed countries.
