Abstract:
The stability of money demand is a crucial element for monetary policy in a given economy. The value of money is determined by the supply and demand in the market of money. Policy makers use the interest as a key tool to stabilize the market and maintain the equilibrium. In the long run, the overall level of prices adjusts to the level at which the demand for money equals to supply. This research study was undertaken to investigate the stability of money demand function and its implications on the conduct and implementation of monetary policy in Rwanda over the period of 32 years (1990-2022).
The general objective for this research study was to examine the stability of money demand and its implication on the conduct and implementation of monetary policy in Rwanda. The researcher used time series data extracted from the International Monetary Fund (IMF) database on Rwanda. Broad Money (M3), Gross Domestic Product (GDP), Inflation rate, Interest rates (deposit and lending rate) and the exchange rate were used as determinants of money demand. Co-integration, Error Correction Model and Diagnostic tests were also employed to test the stability of money demand and its relationship with its determinants. The co-integration test found that there is a long run relationship between money demand and its determinants whereas the Error correction model tested the short run relationship between money demand and its determinants, in addition, the diagnostic tested that the time series data exhibit the OLS classical assumption.
In the long run relationship, the findings show that the broad money (M3) is associated with GDP at 1 %, lending rate at less than (-15%), deposit rate at 0.7 %, inflation rate at less than (-3) percentage point, and exchange rate at less than (-2 %). To this, the short run tested the adjustment to the equilibrium and showed the negative result of (-0.083770) which indicates that money demand adjusts itself from disequilibrium to the equilibrium.
Generally, based on the findings, the researcher concluded that the used determinants of money demand are statistically significant and that there is a stable money demand function in Rwanda over the research period from 1990 up to2022.
