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Economic Change and Restructuring

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02-01-2020

Exchange rate changes and money demand in Albania: a nonlinear ARDL analysis

Authors: Mohsen Bahmani-Oskooee, Ilir Miteza, Altin Tanku

Published in: Economic Change and Restructuring | Issue 4/2020

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Abstract

A good part of the empirical literature on money demand focuses on searching for a stable long-run money demand function, an essential part of a successful monetary policy. Beyond the typical money demand specification, which includes income and interest rates, Mundell (Can J Econ Polit Sci 29:475–485, 1963) made a case for the exchange rate as an important determinant of money demand working through currency substitution. This paper contributes a new approach to test the short- and long-run effects of currency fluctuations on money demand in Albania, a small open economy without deep financial markets. More specifically, we examine the case for asymmetric effects of exchange rate fluctuations on money demand by using a nonlinear adjustment mechanism within an ARDL model. Using data for 1996–2016 from Albania, we show that the money demand is stable in both the linear and nonlinear specifications. The nonlinear model reveals an asymmetric effect of exchange rates on money demand, with depreciations reducing money demand, likely due to a substitution effect amplified by a relatively dollarized economy.

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Once normalization takes place we have \(b = \frac{{\rho_{1} }}{{ - \rho_{0} }},\;c = \frac{{\rho_{2} }}{{ - \rho_{0} }},\;d = \frac{{\rho_{3} }}{{ - \rho_{0} }}\).

Note that Pesaran et al.’s (2001) critical values are for large samples. For small samples such as ours, we use critical values supplied by Narayan (2005).

See Pesaran et al. (2001).

Studies by Pesaran and Shin (1995a, b), Pesaran et al. (2001) posit that when a system contains both I(0) and I(1) series, use of conventional cointegration tests can bias the results of the long-run equation.

See Shin et al. (2014, p. 291).

Under this alternative test, following Bahmani-Oskooee and Tanku (2008) we use normalized long-run estimates from Panel B and long-run model (1) and generate the error term called ECM. We then replace linear combination of lagged level variables in (2) by ECM_t−1 and estimate the new specification after imposing the same optimum lags from Panel A. A significantly negative coefficient attached to ECM_t−1 will support cointegration. Since the t test with new critical values is used to judge significance of this estimate, the test is also known as the t test for cointegration. Like the F test, Pesaran et al. (2001, p. 303) also tabulate an upper and a lower bound critical values for this test. However, since their critical values are for large samples, we will rely up on Banerjee et al. (1998) who introduced this test within Engle–Granger method and who tabulated critical values for small samples too.

Other diagnostics are similar to those of the linear model with no need for additional analysis. For some other application of these and other nonlinear methods see Delatte and Lopez-Villavicencio (2012), Nusair (2012), Wimanda (2014), McFarlane et al. (2014), Kisswani and Nusair (2014), Gogas and Pragidis (2015), Baghestani and Kherfi (2015), Zemami and Ben-Salha (2015), Bahmani-Oskooee and Durmaz (2016), Bahmani-Oskooee et al. (2015, 2017a, b, 2018, Bahmani-Oskooee et al. 2019a), Al-Shayeb and Hatemi-J.(2016), Lima et al. (2016), Arize et al. (2017), Gregoriou (2017), Olaniyi (2019), and Istiak and Alam (2019).

The six parliamentary elections during our study period we held on 5-26-1996; 6-23-1997; 6-24-2001; 7-3-2005; 6-28-2009; and 6-23-2013. The six local elections were held on 10-13-1996; 10-1-2000; 10-12-2003; 2-18-2007; 5-8-2011; and 6-21-2015. Each dummy took a value of 1 during the quarter in which the election was held and zero otherwise. For election details and dates see https://www.osce.org/odihr/elections/albania?page=2.

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Title: Exchange rate changes and money demand in Albania: a nonlinear ARDL analysis
Authors: Mohsen Bahmani-Oskooee
Ilir Miteza
Altin Tanku
Publication date: 02-01-2020
Publisher: Springer US
Published in: Economic Change and Restructuring / Issue 4/2020
Print ISSN: 1573-9414
Electronic ISSN: 1574-0277
DOI: https://doi.org/10.1007/s10644-019-09261-9

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