Revisiting the Demand for Money in Saudi Arabia

Transcription

1. WP /19/01 SAMA Working Paper: Revisiting the Demand for Money in Saudi Arabia January 2019 By Moayad H. Al Rasasi, PhD John H. Qualls, Ph.D. Economic Research Department Economic Research Department Saudi Arabian Monetary Authority Saudi Arabian Monetary Authority 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. Revisiting the Demand for Money in Saudi Arabia Moayad H . Al Rasasi1, Ph.D. John H. Qualls2, Ph.D. Economic Research Department Economic Research Department January 2019 Abstract This paper revisits the issue of the demand for money (in this case, M3) in the Kingdom of Saudi Arabia. Well-known standard analytical techniques were employed, including tests of the data for unit roots, cointegration relationships, and the use of error correction modeling to estimate income elasticities and the impact of interest rates on money demand. However, this paper differs from most in its attention to the data used in the analysis, specifically, the data for M3, which is the dependent variable. Two separate (but related) issues were addressed – the traditional way of measuring the money supply and its impact on the models using it, and the fact that monthly and annual money supply data prior to mid-1988 are still published using the Hijra fiscal year, since monetary statistics were not kept on a Gregorian basis. The problems that these issues cause are examined and revised M3 data series are tested. Addressing both of these problems is done by converting the Hijra-based data into a Gregorian basis and using the monthly average of M3 for the annual series, rather than the end of year data traditionally used. The use of the new series appears to result in better-fitting and more stable models. This paper recommends that future statistical research, particularly using pre-1988 data, use the revised data in place of the currently published series. Keywords: Money Demand; Cointegration; Hijra data; Gregorian data; ECM; Saudi Arabia. JEL Classification Codes: C13, C22, E41, E52, F41 1 Author contacts: Moayad Al Rasasi, Economic Research Department, Saudi Arabian Monetary Authority, P.O.Box 2992 Riyadh 11169, Email: malrasasi@sama.gov.sa 2 Author contacts: John Qualls, Economic Research Department, Saudi Arabian Monetary Authority, P.O.Box 2992 Riyadh 11169, Email: jqualls@sama.gov.sa 2
3. 1 . Introduction The conduct of monetary policy is one of the most important and essential tasks that a country’s Central Bank has. The management of the country’s money supply is essential to the conduct of this policy. This task is particularly important to developed economies with floating currencies, whose livelihood depends on the competitiveness of their exports and their import-competing industries, and whose capital spending is influenced by the cost of capital, and both investment and personal consumption are directly affected by the level of interest rates. However, even in a resource-rich developing economy with a pegged currency, whose economy is less interest-sensitive, with businesses that are less leveraged and consumers who carry lighter debt loads, the management of the money supply is still of critical importance. Liquidity management, the control of inflation, and the safety and security of the nation’s financial institutions all depend on the ability of the Central Bank to closely match the supply of and demand for money, in its various forms. Economists put much effort in understanding the behavior of money demand; therefore, various theories (e.g., Quantity Theory, Keynesian Theory, Inventory Theory known as “The Baumol-Tobin Model”, Friedman’s Theory, and Cash-inAdvance Model) have attempted to lay out the key determinants of money demand. With all the theoretical foundations being developed, empirically there has been 3
4. continuous research validating these theories ; Banafea (2012) sheds light intensively on the empirical studies conducted on advanced and less advanced economies based on the materialized theories. It is essential to emphasize that our motivation for this research arises from several sources. First is the issue of the traditional measurement of money supply, which uses the end-of-period convention. In other words, the money supply measurement for an entire year is based on a snapshot of various December 31 commercial and central bank balances. In sharp contrast, the other variables that enter into the determination of the money supply (the Consumer Price Index “CPI”, real Gross Domestic Product “GDP”, and the interest rate) all are based on averages (or totals, in the case of GDP) of monthly (or even weekly or daily) data. Therefore, our purpose is to examine if the use of monthly average money stock data would result in more robust relationships being estimated. The next issue is the fact that the existing monthly money supply data prior to 1988 is based on the Hijra fiscal calendar, which consists of 12 Hijra months (based on the lunar calendar) and a 354-355 day year, versus the Gregorian calendar with a 365-366 day year. To further simplify matters, the Hijra fiscal year used for the published money supply data prior to mid-1988 began on the first day of the seventh Hijra month (Rajab I) and ended on the last day of the sixth month (Jumada II). 4
5. The combination of these two factors results in having inaccurate estimation results and this problem gets even worse the further back in time we go . As an example of the distortions that this causes, consider the following. In Saudi Arabian Monetary Authority’s (SAMA) latest Annual Report database, the M3 figure for the Hijra fiscal year that allegedly corresponds to December 31, 1980 is actually the M3 value at the end of the Hijra fiscal year AH 1400/1401 (30 Jumada II, 1401), which corresponds to May 4, 1981, over four months later than December 31, 1980. In order to rectify this problem, SAMA’s Research conducted by Qualls et al. (2017) developed a methodology to convert the pre-1988 Hijra data into its Gregorian equivalent. Although the converted data are estimates, they are much more precise than using the Hijra data as published.3 This paper will be the first that uses the new Gregorian money supply data for analytical econometric analysis of monetary aggregates.4 The rest of the paper is organized as follows: whilst section 2 describes the money demand theoretical framework, section 3 provides an overview of the empirical research with notable attention to research focusing on Saudi Arabia. The 3 For instance, the end-of-1980 money supply figure used in our calculations for this paper is the weighted average of the monthly figures for Muharram and Safar 1401, corresponding to the December 7, 1980 to January 6, 1981 period. Common sense would tell us that this figure would be closer to the December 31, 1980 actual number than would the reported M3 figure for the end of Hijra fiscal 1400/1401, on May 4, 1981. 4 It should be noted that the other data series used in the analysis were either always published on the Gregorian basis (CPI and interest rates), or were converted by GASTAT using similar methodology applied to annual data (GDP). 5
6. description of data is contained in section 4 , while the econometric methodology and results are described in section 5. The conclusion is contained in section 6. 2. Theoretical Background Despite the presence of various theories (e.g., Quantity Theory, Keynesian Theory, Inventory Theory known as “The Baumol-Tobin Model”, Friedman’s Theory, and Cash-in-Advance Model), formulating the determinants of money demand, the mainstream of empirical studies assessing the behavior of money demand still relies on the Keynesian’s theory in order to understand the relationship between money demand and its determinants. Consequently, this paper will rely on the Keynesian theory to assess the relationship among the demand for money and its determinants in Saudi Arabia. Likewise, prior to proceeding with the empirical analysis, it is also important to understand the foundation of Keynesian theory. According to this theory, people demand money either for daily transactions, precautionary purposes, or speculative purposes, as a “store of wealth.” Based on these motives, it can be inferred that the first and second motives for people to hold money are related proportionally to income, which explains the positive relationship between income and money demand. With regard to the third motive, it can be inferred that there is a negative relationship between money demand and interest rate. Furthermore, when people choose to hold money for speculative purposes, through investing in bonds or other 6
7. forms of financial securities, they may tend to follow this behavior when interest rates are high; however, with lower interest rates, people may choose to hold money in cash rather than financial assets, since the opportunity cost of holding money is lower. With this backdrop borne in mind, according to this theory, real money demand (