The Demand for Real Money Balances in Zimbabwe: An Error Correction Estimation

Abstract

Purpose: The purpose of the study is to examine the stability of the money demand function in Zimbabwe. Understanding, the money demand function is a prerequisite for effective monetary policy formulation and understanding the monetary transmission process and shocks propagation in the economy.

Materials and Methods: The study employs the error correction modeling methodology to investigate the money demand function for Zimbabwe using quarterly data from 2017q2 – 2023q2. The analysis is expanded to characterize the monetary transmission mechanism following a shock to the price level and how the demand for real money balances responds to both single period and multiple shocks.

Findings: The findings confirm a stable long run money demand function that is subject to short run dynamics. In addition, real money demand responds positively to real GDP (Scale factor) and inversely related to the price level (inflation).  Short term dynamics (particularly inflation expectations) compound real money demand collapse in response to rising inflation.

Implications to Theory, Practice and Policy: Monetary Policy must aim to collapse inflation expectations through a tight monetary control program and a functioning interbank market for foreign exchange to avoid surging parallel market activity.