Modeling Money Demand under the Profit-Sharing Banking Scheme: Evidence on Policy Invariance and Long-Run Stability.

This paper extends the literature on interest-free banking systems by modeling money demand equations for Iran which has followed the profit-sharing scheme since the mid-1980s. Using quarterly data spanning the period 1966-2001, we estimate two alternative demand equations for M1 and profit-sharing deposits. Unlike prior research, this paper focuses on whether the estimated equations are policy invariant in addition of being temporally stable in the short- and long-run. Our empirical results persistently suggest that the two money demand models, and especially the demand for profit-sharing deposits, are structurally stable and policy invariant despite the numerous shocks that have characterized Iran in recent years. These results provide another piece of evidence supportive of the merit of the interest-free banking system, and suggest that profit-sharing monetary aggregates represent a credible instrument for monetary policy-making in Iran.