GDP Structure Effects on Macro-Money Demand : Herfindahl Index Evidence for India

Money is a medium of monetary policy transmission. In this connection, no other macro-behavioral function is subjected to more modeling modifications and regression rigors than the macro-money demand function. Monetary policy planning hinges on the parameter estimates of the money demand function. An emerging market economy undergoes structural change in the sector GDP composition unlike a structurally-invariant advanced economy. This is likely to introduce bias in the income elasticity parameter estimate especially. The present study investigates this using the Herfindahl (H) index as a proxy for the GDP composition concentration. The 1-3 years deposit rate and call money rate are alternately used for the opportunity cost variable. Maximum likelihood estimates have shown a statistically highly significant positive coefficient for the H variable besides equally highly significant scale and opportunity cost variables with their expected respective signs. This empirical evidence suggests that the conventional specification contains a serious specification error. The implication of the result is that as the sector GDP concentration increases, the demand for real money balances also increases though quite less proportionately, indicating the absence of any economies of GDP concentration