Asymmetric exchange rate effect on money demand under open economy in case of India

Abstract

The study tries to explore the asymmetric relationship between money demand and exchange rate in case of India. The period of study is April 2004 to November 2015. For money demand both narrow (M1) as well as broad (M3) monetary aggregates have been used. In this paper, it is shown that failure to find a significant relationship between the exchange rate and the demand for money could stem from the assumption of linear dynamic adjustment process among the variables. With the help of non-linear ARDL it is found that rupee appreciation and rupee depreciation have an asymmetric effect on the demand for money in India both in the short run and the long run. The results showed that the coefficient of positive partial sum (Ln EX+) which represents rupee appreciation is significant and negative, while for negative partial sum (LnEX-) the coefficient is positive and significant The combined implication of the results is that exchange rate movement effects demand for money through the wealth effect not through the mechanism of change in expectations.