Stability of Money Demand and Monetary Policy in Papua New Guinea (PNG) : An Error Correction Model Analysis

An error correction model (ECM) is used to study the properties of money demand and to evaluate the appropriate monetary policy in PNG. The study confirms that the determinants of money demand are real GDP, nominal interest and inflation rate. The income elasticity of money demand is very low. The demand for money in PNG was stable during 1979-95, suggesting that the monetary targeting regime by the PNG Central Bank is feasible. However, as PNG proceeds with economic reforms that includes financial sector reform and a floating exchange rate regime, the stability of the demand for money may have to be re-examined periodically. The best approach for conducting the monetary policy in PNG is to target the inflation rate