On the stability of demand for money in a developing economy: some empirical issues

In recent years, a number of developing countries have undergone extensive reforms in the financial sector. The effects of this underlying financial innovation process on the stability of demand for money have seldom been studied in the context of developing countries. Nevertheless, these changes in the financial sector highlight the transition from one regime to the other. This need necessarily follows that such a process has to be accounted for in the long-run demand for money estimation. Here, we use a three-step testing procedure to study the implication of the reform process on the stability of demand for money. To account for the abovementioned changes, we specify the demand for money in an open economy framework using data from India. An estimation procedure accounting for these changes in the specification of demand for money suggests that financial deregulation and innovation did affect the empirical stability of demand for money in India.