On the nexus between Stock Market Fluctuations and the Demand for Money in Saudi Arabia

Transcription

1. WP /19/05 SAMA Working Paper: On the nexus between Stock Market Fluctuations and the Demand for Money in Saudi Arabia June 2019 By Moayad Al Rasasi, PhD Fares Rawah Bander Alghamdi Economic Research Economic Research Economic Research Department Department Department Saudi Arabian Monetary Authority The views expressed are those of the author(s) and do not necessarily reflect the position of the Saudi Arabian Monetary Authority (SAMA) and its policies. This Working Paper should not be reported as representing the views of SAMA
2. On the nexus between Stock Market Fluctuations and the Demand for Money in Saudi Arabia1 June 2019 By Moayad Al Rasasi , PhD Economic Research Department Fares Rawah Economic Research Department Bander Alghamdi Economic Research Department Saudi Arabian Monetary Authority Abstract This research paper estimates the augmented money demand function for Saudi Arabia while incorporating stock prices as one of the key determinants and utilizing quarterly data spanning over the period of 2010-2018. The estimated money demand function coincides with theoretical expectation regarding income and interest rate over long run. In Particular, the demand for money is statistically significant and positively related with income while it’s negatively related with interest rate. On stock prices, the findings suggest that they are statistically significant and have positive impact on money demand over the long run. Moreover, the estimated error correction model indicates that it takes money demand about two quarters to adjust to its equilibrium condition. Key Words: Stock Prices; Money Demand, Cointegration, Saudi Arabia, ECM JEL Classification Code: C12, C13, C22, C52, E12, E41, E52, F41 1 Author contact: Moayad Al Rasasi, Email: malrasasi@sama.gov.sa; Faris Rawah, Email: frawah@imf.org; Bander Alghamdi, Email: bkalghamdi@sama.gov.sa 2
3. 1 . Introduction Money demand remains as one of the most important topics in monetary economics that has been under investigations intensively from researchers and policymakers. Therefore, there has been a vast literature, theoretically and empirically, attempting to comprehend the dynamics of money demand and identify its key determinants. The prevailing empirical research points out to essential factors other than those specified by theories contributing to explaining the behavior of money demand. For instance, oil prices, exchange rate, asset prices, and inflation are key elements explaining the variation in money demand in selected economies as empirical evidence shows on different countries. An additional factor affecting the demand for money being identified by Friedman (1988) is stock price that might have a positive or negative impact on money demand. Based on Friedman’s argument, the positive impact of stock prices on money demand comes from three channels. First, rising stock prices may generate additional wealth notably when the income generated from these stocks being sorted. Secondly, higher returns of stock prices could encourage people to demand more money, especially when these returns are expected to be persist. The last channel could be through the increase of stock prices that may lead to higher volume of financial transaction leading to higher demand 3
4. for money in order to facilitate such transactions . Conversely, the negative association between stock price fluctuations and the demand for money, according to Friedman (1988), might be observed when stock prices booming discourage people to demand money. In other words, people would prefer to keep their stocks instead of holding money. To this point, the impact of stock price variations on money demand seems to be undetermined from theoretical perspectives, and hence warrants further empirical evaluation. Therefore, some economists follow the steps of Friedman (1988) by augmenting stock prices as a key determinant of money demand. Their empirical evidence seems to vary from an economy to another depending on the structure of these economies. Nonetheless, money demand literature for Saudi Arabia does not consider the role of stock prices in capturing changes in money demand. Henceforth, the main objective of this study is to analyze whether stock market has a positive or negative impact on the demand for money in Saudi Arabia. This is important for policymakers especially after the inclusion of the Saudi stock market on emerging market indices by FTSE Russell as well as the inclusion of the Saudi stock market on the MSCI (Modern Index Strategy Indexes) and S&P DJI (Standard and Poor Down Jones Index) during 2019. In other words, understanding money demand is vital since it helps monetary 4
5. policymakers in designing the appropriate policies and conducting timely intervention. For this reason, it is important before estimating money demand function to ensure that it is specified correctly. The reminder of this this research paper is outlined as follows. Section 2 provides a theoretical foundation followed by literature review in section 3. The employed dataset is contained in section 4, while the utilized empirical analysis is presented in section 5. The conclusion of the paper is contained in section 6. 2. Theoretical Background Most theories, when modeling money demand, consider a scale variable for economic transaction and an opportunity cost measure of holding money as key determinants of money demand as documented by Ericsson (1998). In particular, the specification of real money demand function in the long run takes the following form.