Modeling Demand for Money in Nepal

In this paper, we estimate money demand functions for Nepal employing Johansen's tri-variate Conintegration method for the period of 1974/75-2009/10. In line with the previous studies, both narrowly defined real money demand ( 1 m ) and broadly defined real money demand ( 2 m ) are found to be a stable and predictable function of real income and interest rate albeit disequilibrium corrects more rapidly in 1 m compared to 2 m . We reject the null hypothesis that income elasticity of money in both functions is unitary with satisfying homogeneous postulates. Further, we reject the null hypothesis that long run determinants of 1 m and 2 m are weakly exogenous. Based on these findings, we conclude that money demand functions are useful for conducting monetary policy in Nepal.