Monetary Aggregation and Speculative Real Money-Demand Equation: Theories, Evidence and Policy

Abstract

This paper uses Kenyan monetary data from 2000 to 2020 to examine whether new financial products have systematically changed the traditional relationship between monetary aggregates, interest rates and income by empirically analysing the log-linear money demand functions of the "partial adjustment" variety. In Kenya, financial market developments, financial deregulation and growth of cash-management methods offer a broad assortment of financial assets. Several assets possess investment and transaction abilities, which blurs the difference between holding money for transactions and assets and accounts for the erratic behaviour of broad money (𝑀2). Varying growth rates of monetary aggregates provide evidence that monetary policy has been destabilizing, with the effects of the growth of money substitutes on real income and interest rate elasticities of demand for money in Kenya remaining unclear. The study finds that innovations in the payments process and changes in the regulatory environment have affected the demand for money in Kenya.

Keywords: money demand; interest-elasticity; income-elasticity; monetary policy, elasticities of substitution; financial assets; cash management; financial innovation

JEL Classification: E41 and E52