Bahmani - Exchange Rate Volatility and Demand for Money in Iran

Bahmani - Exchange Rate Volatility and Demand for Money in Iran

12 Pages · 2010 · 142 KB · English

black market exchange rate and not the official exchange rate should be included in the money The long-run income elasticity is 1.0086 and highly significant,

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Exchange Rate Volatility and Demand for Money in Iran Sahar Bahmani School of Economic Development College of Business Administration Georgia Southern University Statesboro, Georgia 30460 E-Mail: [email protected] And Mohsen Bahmani-Oskooee Department of Economics The University of Wisconsin-Milwaukee Milwaukee, Wisconsin 53201 E-Mail: [email protected] ABSTRACT In 1963, Nobel Laureate, Robert Mundell (1963) proposed the idea that the demand for money could depend on the exchange rate, in addition to income and the interest rate. In this paper, by using data from post revolutionary Iran and the bounds testing approach to cointegration, we attempt to discover another determinant of the demand for money. We argue that, in addition to Mundell’s theory on exchange rate being an important determinant of the demand for money, exchange rate volatility also serves as another important variable than impacts demand for money and should therefore be included in the money demand function. Our results reveal that indeed, exchange rate volatility has both short-run as well as long-run effects on the demand for real M2 monetary aggregate in Iran, during the post revolutionary period of 1979 to 2007, and is therefore a very important determinant when it comes to the demand for money. Key words: Money Demand, Exchange Rate Volatility, Bounds Testing, Iran. JEL Classification: E41, F30 1 I. Introduction In 1963, Nobel Laureate, Robert Mundell (1963) was the first to propose the idea that the exchange rate is another important determinant of the demand for money because it plays a critical role and should therefore be included in the money demand function. He asserted that, “The demand for

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