Money Demand Stability and Its Implications for the Conduct and Implementation of Monetary Policy in Rwanda

Abstract

From international experience, instability of the relationship between monetary aggregates and goal variables (inflation and nominal income) and the weak relationship between money and nominal income implies that hitting a monetary target will not produce the desired outcome for a goal variable such as inflation, it make monetary targeting problematic, which is the main cause of  wide spread changes from monetary targeting to inflation targeting regime, this attempts the researcher to carry out an empirical analysis on stability of money demand function and its implication on monetary policy in Rwanda by assessing the stability of the relationship  between monetary aggregate M3and  goal variable (inflation) through real money demand function and its determinants namely real gross domestic product (Y), T-bill rate (TB), exchange rate (ER), bank average deposit rate (DR) and  bank average lending rate (LR) in Rwanda covering the period using quarterly data (2004q1-2014q4) using  Johansen co-integration approach and error correction model (ECM),the results reveals the co-integration between variables and therefore the diagnostic tests were conducted and confirm the stability of money demand in Rwanda ,also empirical evidence reveals that in the long run real broad money demand is positively linked to GDP growth and bank deposit Rate, while real demand for money responds inversely to exchange Rate changes, T-bills rate changes  and bank average lending rate.