Money demand stability in India: allowing for an unknown number of breaks

One of the most widely researched macroeconomic relationships is money demand stability, which helps monetary authorities understand what motivates economic agents hold real money balances and whether it can predict inflation. However, endogenous structural shocks to macroeconomic fundamentals have often been criticized for distorting the equilibrium relationship among economic variables. These shocks usually stem from socioeconomic and political changes, behavior of economic agents, and random shocks. We examine the presence of cointegrating relationships between money demand and scale and opportunity cost variables while allowing for multiple endogenous structural breaks in the cointegrating vectors in the Indian context for the period 1996:Q2–2021:Q2. We utilize the Narayan and Popp (J Appl Stat 37(9):1425–1438, 2010) test to identify the break dates in each series and then employ the Maki (Econ Model 29(5):2011–2015, 2012) cointegration approach to establish the presence of long-run relationships between money demand and its covariates. Our study finds the presence of stable long-run relationships in the money demand function, implying that monetary authorities may target narrow and broad monetary aggregates as an indicator or treat them as an information variable to anchor the inflation expectations of economic agents under the current flexible inflation-targeting framework.