AKSUM UNIVERSITY

COLLEGE OF BUSINESS AND ECONOMICS

DEPARTEMENT OF ECONOMICS

THE DETERMINANT OF MONEY DEMAND IN ETHIOPIA

A SENIOR ESSAY SUBMITTED to the economics department

IN PARTIAL FULFILMENT OF THE REQUIREMENT S FOR the
degree of BACHELOR OF ARTS (BA) IN ECONOMICS

BY-BELETE MENGISTU

ADVISOR- ABREHAM G.

JUNE-2009/2017

AKSUM (, ETHIOPIA)

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Acknowledgement

First and for most I wish to express my sincere thanks to the almighty
god. Who has given my health, strength, tolerance to rich at this stage.

Next my special tanks got my advisor instructor Abraham G. for his great
advise, assistance guidness, and comment in course of these senior essay
preparation.

In addition to this, I would like to tanks the workers of internet café,

digital library and library of Aksum. Finally, the last but not the least my
deepest and heart full tanks got to my families, my friends and the
department of economics for their moral, materials and financial
assistance.

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Table of Contents
TABLE OF CONTENTS
CONTENT PAGE

Acknowledgement …………………………………………………………………………………………………i

Table of contents ……………………………………………………………………………………………………….ii

List of growth rate tables ………………………………………………………………………………….………….…IV

List of table figures……………………………………………………………………………………………………….…………v

Acronyms ………………………………………………………………………………………………………………………VI

Abstract ……………………………………………………………………………………………………………………………..vii

CHAPTER-ONE

1. INTRODUCTOIN
1.1. Background of the study ……………………………………………………………………………………………1,2
1.2. Statement of the problem …………………………………………………………………………………………….3
1.3. Researches questions ……………………………………………………………………………………………………4
1.4. Objectives of the study …………………………………………………………………………………………………5
1.4.1 General objective …………………………………………………………………………………………………5
1.4.2 Specific objective …………………………………………………………………………………………………5

1.5 Scope of the study …………………………………………………………………………………………………………5

1.6 Significance of the study ……………………………………………………………………………………………….5

1.7 Limitation of the study ………………………………………………………………………………………………….6

1.8 Methodology of the study…………………………………………………………………………………………..…6

1.9 Organization the paper ………………………………………………………………………………………………….7

CHAPTER-TWO

2. LITERATURE REVIEW

2.1 Theoretical frame work ………………………………………………………………………………………………….8

2.1.1. Definition of money ……………………………………………………………………………………………8

2.1.2. Functions of money………………………………………………………………………………………….…9
2.1.3. Theories of money demand…………………………………………………………………………….…11
2.1.4. Determinants of money demand theories …………………………………………………………13
2.1.4.1. The demand for money by individuals…………………………………………………………….13

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 2.1.4.2 Aggregate money demand ………………………………………………………………………………14
2.1.5. Equilibrium in the money market………………………………………………………………………15

2.2. Empirical literature review …………………………………………………………………………………………16

2.2.1 An overview of historical development of money in Ethiopia ………………………….…17

CHAPTER-THREE

3. DATA AND METHDOLOGY OF THE STUDY

3.1. Types an source of data……………………………………………………………………………………………….19

3.2. Method of data analysis……………………………………………………………………………………………….19

3.3. Model f specification…………………………………………………………………………………………………..20, 21

3.3.1. Explanation of variable and hypothesis……………………………………………………………………22

3.3.1.1. Dependant variable…………………………………………………………………………………………….22

3.3.1.2. Independent variables………………………………………………………………………………………23, 24

3.4. Econometrical testes ………………………………………………………………………………………………25, 26, 27

CHAPTER-FOUR

4. RESULTS AND DISCIUSSION

4.1. Descriptive analysis ………………………………………………………………………………………………28

4.1.1. Development of monetary aggregate in Ethiopia …………………………………….29, 30

4.1.2. The factor determined the money demand in Ethiopia……………………...31, 32, 33

4.2. EONOMETRICS ANALAYSIS…………………………………………………………...34, 35, 36,37,38,39

4.3. ESTMIATION RESULTS AND ANALAYSIS …………………………..………………40, 41, 42 43, 44,

CHAPTER FIVE

5. CONCLUTION AND RECOMMENDATION

5.1. CONCLUTION …………………………………………………………………………………………………………45

5.2. RECOMMENDATION …………………………………………………………………………………........46, 47

BIBLOGRAPHY ……………………………………………………………………………………………………….48, 49

APPENDIX ………………………………………………………………………………………..........
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iv
LIST OF FIGERS AND TABLE FIGERS
4.1 Development in monetary aggregate ………………………………………………………………………………………28

Table 4.1 growth rate of money demand and real GDP …………………………………………………………………29

Table 4.2 average growth rate of varies year interval ……………………………………………………………………30

Table 4.3 Dickey fuller (DF) test of stationary at level ………………………………………….……………………….34

Table 4.4 Augmented dickey fuller (ADF) test for first difference of data ………………………………..…..35

Table 4.5 Test for multicollinearity ………………………………………………………………………………………………..39

Table 4.6 Stata results at first and second differenced …………………………………………………………..…40

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ACRONYMS

ADF= AUGMENTED DICKEY FULLER

CSA=central statically Agency

CLRM=Classical linear regression model

OLS=Ordinary lest square

EPRDF=Ethiopia people revolutionary democratic front

ER=exchange rate

GTP=growth and transformation plan

IMF=international monetary fund

INF=inflation rate

MD =money demand

MOFED=ministry of finance and economic development

NBE=national bank of Ethiopia

R=interest rate

RGDP=real gross domestic product

SAP=structural adjustment programs

WB = World Bank

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ABSTRACT
The study conducted to identify the determinant of money demand in
Ethiopia using time series data for year 1982-2014 collected from
different governmental organization like NBE, MOFED, WB and other
annual bases. The data were analyzed using both descriptive and
econometric methods. in the descriptive part the study found that the
macro economic performance of in Ethiopia during the military regime
of the degree was unsatisfactory, but with the change of government in
1991 there come radical change in economic orientation .in
econometric analysis the first step was specification or formulation of
the model for money demand function based on economic theory of
money demand and the model tested for ordinary least square method
(OLS) approach. The study found that growth real GDP has significant
positive effect on money demand. the exchange rate ,inflation rate ,and
nominal interest rate are also significant and have negative relationship
with money demand finally the study recommended that should be
appropriate policy towards money demand condition related to real
GDP ,inflation, exchange rate and nominal interest rate.

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 CHAPTER ONE
1. INTRODUCTION
1.1. Back ground of the study
The demand for money is verily researched area of economics. This is
due to the important role of private economic agents behavior
indetemining the outcome to economic policy reform that target
monetary aggergat.However, mach of the empirical research has
focused on developed economics.

During the last decade of the 20th century most of African countries
south of Sahara stated to important economic liberalization measures
and structural program(SAP).this changed situation has made empirical
investigation of money demand to remain of interest rate to
researcher.(Mishikin,2004).

Ethiopia is one of the sub Saharan African countries which have start
structural adjustment program(SAP).the reform measures implemented
safer have challenged the price of asset and their changes might have
affected the price of asset and this changes might have affected the
demand for cash balance farther more, Ethiopia is developing economy
with heavy dependence on external assistance. This situation makes the
beaver of domestics agent to the strongly influenced by external
economic and monetary development. This make is appropriate to
including a variable that measures changes in exchange rate. The
presence of stable money demands functions greatly facilitate the
conduct of monetary policy. If tells policy maker have different variables
are affected by change in the money supply.(Samual,2005).
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Ethiopia had been ruled by the centrally planning socialist regimes for
nearly two decades (1974-1991).during this period most of the macro
economic variables such as interest rate, exchange rate and prices of
major commodities were administrate controlled. This has resulted in
macro economics in balance and generally poor performance of the
economy. After the overall throw of the socialist regime in may 1991,
the country is now in transition to market oriented economics system.
This was the time were structural adjustment program (SAP) was pre
cashed to b ea sleeping stone to adjust macroeconomic in balance and
ensure sustainable economic growth. Hence the government has
accepted and implementing the SAP by the IMF and WB since October
1992. According to this comprehensive economic reform program,
series of policy reform measures and regulations have been made in
view of correcting the distortions in the macro economy and fostering
economic growth.

Therefore, identifying and finding basic determinants of money

demand is a tool to provide guidance to policy maker and also it
indicates the effectiveness of monetary policy because monetary policy
is one of the policy instruments employed to achieve rapid economic
growth and stabilization.

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1.2. Statement of the problem
Ethiopia is one of the poorest countries in the world are by ranking
132th out of total of 189 countries in pre capital basis (WB,
2014/15).Ethiopia economy like in other developing countries has poor
performance over effectiveness of macroeconomic policy. Therefore,
Ethiopia or other developing countries introduce different
macroeconomic policy reform to increase the performance their
economy.

In the case of Ethiopia those macro economic reforms are structural

adjustment program and growth and transformations plan since
september2010.the above program is important for the economic
growth and development of the country.

Money demand function implies that demand for money depends

up on a variable that reflects the level of transactions in the economy
such as real income and another variable that reflect the opportunity
cost of holding money such as interest rate. Theoretically, the
relationship between income and money demand is expected to be
positive, while the relationship between the interest rate and money
demand is expected to be negatively related. (Mankiw and
scarth,2002).these relationship are important in macro economic
analysis particularly in selecting appropriate monetary policy actions,
were the stability of the money demand function is consider to be an
important pre-request for effective money target. Moreover finding and
testing the stability of money demand variable are important as it
indicates that the effectiveness and the conduct of monetary policy. The

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demand for money has link between economic activity and monetary
policy.(AL.Saji,1998).

The demand for money is affected by several factors such as the

level of income, interest rate, and inflation as well as a certainty about
the future. even if there are some empirical study on the determinant of
money demand in Ethiopia, recent studies with respect to conduct
policies and as compared to developed countries are still in sufficient
and money works and studies stated to analysis the money demand in
Ethiopia is using narrow money demand.(Haile kibret,2003).other
researcher has designed to find and identify the determinant of money
demand in Ethiopia and to analyze it using broad money demand.

Behailu (2003) estimated broad money demand with dependent

variable and real GDP; real effective exchange rate used as independent
variables and used annual data for the 1967-2002.according to Behailu,
the rate exchange and realGDP is positively affected money demand.
But real effective exchange rate is negative affected money demand. So
this research has designed to find and identify and analyze the basic
determinant of money demand in Ethiopia using broad money demand
variable independnant variables are RGDP, inflation rate, interest rate,
and exchange rate used annual data for the 1982-2014.

1.3 Research questions

1. What is the determinant of money demand in Ethiopia?

2. In what way the researcher show some police implications?

3. How to show the trend of identified determinant of money demand?

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1.4 objective of the study
1.4.1 General objective
The main determinant of the paper is finding and identifying the
determinant of money demand in Ethiopia.

1.4.2 Specific objective

 To show the trend of identified determinant of money demand
 To show the desired response of determinant of money demand
 To show the relation between money demand and determinant of
money demand
1.5 scope of the study
Even if money demand has many dimensions that should be
researched, this study focused on determinant of money demand
in Ethiopia. In this study the research used a time series data to
analyze the determinant of money demand in Ethiopia for the
year1982-2014.the resean for selecting this year: they expected
that to know how much the effect of determinant on money
demand in the period of dergue regime and after the coming of
EPRDF (Ethiopia people revolutionary democratic front) in 1991.
1.6 significance of the study
This paper believed that, this study has much important. The
following point is believed by some of the important of the study.
 For the researcher it may serve as a bench mark to
conduct further in this and other related topics
 It help to assess the effectiveness of monetary policy

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  The study is using full to bridge the research gaps that
are not studded by previous researches. More over
hopes that to encourage other researcher in under
teaching. The study more deeply and broadly.

1.7 limitation of the study

The main limitation of this study were lack of reference materials
such as written documents on money demand in Ethiopia, lack of access
and availability of internet serves constraints.

1.8 methodology and source of data

The data used for this study is collected from secondary sources.
Data obtained from different governmental organization like national
bank of Ethiopia (NBE), central statically authority (CSA), ministry of
finance and economic development (MOFED) and World Bank (WB).

Descriptive and econometrics method used to analyze and interpret

the data are qualitatively and quantitatively. The prefer uses both
methods simultaneously, in descriptive method analyze developmenant
aggregate monetary in Ethiopia theoretically and econometric model
analysis relationship between money demand from independent
variables.

Time series econometric technique applied to analyze data. Time

series stationary test were conducted using augmented dickey fuller test
(ADF).

Model specification in the determinant of money demand

MD=f (real GDP, INF, ER, and R) this equation is

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Ln MD=β0+β1realGDP-β2LnINF-β3lnER-
β4LnR+ei
Were

MD=money demand

RGDP=real GDP

ER=exchange rate

INF=inflation rate

R=interest rate

Ei=error term

1.9 organization of the paper

This paper contained five chapters; the first chapter is
concerned with the introduction part. In this part we include back
ground of the study, statement of the problem, objective of the
study, scope of the study, methodology of the study and
organization of the paper. The second chapter contained the
review of relevant related literature. In this part the theoretical
and empirical literatures reviewed. The third chapter concerned
methodology data. Fourth chapter data analysis and
interpretation. Chapter five contained conclusion and policy
recommendation.

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 Chapter two
2. LITERATURE REVIEW
2.1theoretical frame work
2.1.1 Definition of money
Before discussing the theoretical frame work of money demand, we
began with the definition of money.

What is money and why money is used?

The champers 20th century dictionary (1983) cited in (bain&hawells,

2003) provides the definition of money .it is coin, pieces of stamped
metal used in compare and currently wealth.

The demand for money is closely related to the function and the
definition of money .money can be defined in quit different ways: thus,
the demand for money well be different depending on the combination
of asset that are included in specific monetary aggregate. however,
with some modification a theory of the demand for money (broader)
monetary aggregate can also be developed.Bofinger further explained
that the demand for money is an important building blank in more
economic theory that is it constitutes a main link between the monetary
sphere and the real sector of the economy.(peterBofinger,2003)

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 Money in monetary economics is not identified with total wealth as
the final element as the definition here rather; when we talk at money
we are discussing one part at wealth. An economics definition
concentrates on the earlier elements at dictionary definition; money is
defines by its use in commerce or exchange. This gives as the common
notation at money a medium of exchange or means at payment. in
other word money is the most liquid part of wealth which can be most
readily exchange for good and service.(S.B Guta,2001),but throughout
this paper the definition of money in monetary economics are used.

In general money is anything that is generally accepted in payment

for good and service or in payment of depts.therfore, currency
consisting of dollar bills and coins early fits this definitions and is one
type of money. However, to define money nearly as a currency is too
much narrow for economist. Because checks are also accepted as
payment for purchases, checking account deposits considered as well.
Hence, (Mishkin,2004) further pointed out that a never broader
definition of money is often needed; because other item such as saving
deposits can in effect function as money .if they can be quickly and
easily collected in to currency or checking account
deposits.(Mishkin,2004).

2.1.2 Functions of money

Money has four functions: a medium of exchange, a measure (a
unit of account), a standard of differed payment and a store of value.

Money as a medium of exchange: the primary and

unique functions of money demand are that of acting as a medium of
exchange.thise function of money is so important and unique. We shall
9
use it as the distinguishing characteristics of moneyman characteristics
that will help separate money from other (near- money or non money)
assets. it is this function alone which can help identify money as money.
All other function of money is derived room this primary functions. The
use of money as a common medium of exchange will involve a direct
barter of good and service for good and service. (S.A.Guta, 2001).

Money as a unit of account: money customarily services

are a comer unit of account or measure of value in term of which the
value of all good and service is expressed. This makes possible meang
full accounting system by adding up the values wide variety of goods
and services whose physical quantities are measured in different units
(S.A.Guta, 2001).

Money as a standard of different payment: money

also serves as a standard or unit in term of which differed or future
payment are stated. This applies to payment of interest, rents, salaries,
pensions, insurance premier...etc. in a money using system, the bulk of
differed payment are stipulates in money terms large fluctuations in the
value of money make money not only a poor measure of value, but a
poor standard of differed payment. This is because the value of money
is not something intrinsic to it, but a social phenomenon. This makes
monetary management for the stable value of money socially very
important (S.A.Guta, 2001).

Money as a store of value: that is, members of the public

can hold their wealth in the form of money. This function is derived from
the use of money as a medium of exchange in a two-fold manner. First,
the use of money as a medium of exchange decomposes single barter
10
transaction in to two separate transactions of purchases and sale. The
use of money necessarily separates the two transactions in time. This
will require that the medium of exchange also serves as a store of value.
Second, at least a part of the receipt is held in the form of money for
varying period. All this is encouraged by a unique feature of money that
it is generalized purchasing power, and as such the only perfectly liquid
asset. No doubt, money is not the only store value. There are other
assets of all kinds which also serve as a store of value and complete
with money in this capacity (S.A.Guta, 2001).

2.1.3 Theories of money demand

The demand for money a rises from the two function of money, real
money balances either for a means of exchange or for storing values or
both. There are two views regarding the factors those that change
money function (jingan, 1983).the scale view, assumes a direct
relationship of money demand to changes in income or wealth. while
the substitution view considers in direct relationship of money to the
relative attractiveness of assets that may be substituted for money, the
classical, Keynesian, monetarist approaches and post Keynesian
theorists argue about the theory of the demand for money function
differently. We shall very briefly look in to these theories below.

The classical economists argue that monetary force do not change

real variables such as output and employment. For them money acts
only as a medium of exchange and it facilitates transactions. According
to this theory demand for money is determined by income, which is
assumed tube at full employment level, because their argument is built
on the basis of says law of “ supply creates its own demand”.hence,the

11
number of transaction determines the demand for money and classical
neglect money’s function as a store of value.(Hailekibret,2003)

The Keynesian thought on the other hand argues that change in

money supply may be transmitted to real output and employment
through interest rates amide investment .money is demand for their
motive: namely, the transaction, precautionary and speculative
motives. Money demand for transactions need and precautionary
motives are related to the scale view or income while the speculative
motive refers to functions of the substitution or opportunity cost of
money view. Unlike the classical school, Keynesian argument in
corporate both the medium of change and store of value basic function
of money (HailKibret, 2003).

Monetarist school argues in favor of the classical theory with slight

devition.they agree that money may affect real variables in the short
run only nominal variable or magnitudes changing the long
run.friedman has also studied the demand for money and he suggested
that not only income and interest rate, total wealth also affects the
desire to hold real money balances. He believes that stability of the
demand for money is just a behavioral fact proven by empirical
evidence and the effect of change in money supply on expenditure and
income is predictable.(S.Gahtak,1995).

Although only real variables may change in the short run,

monetarist believe that instantaneous adjustment will take place and
the effect of un anticipated change in money supply only affects
nominal variables in the long run.(S.Gahtak,1995).

The post Keynesian theorists argue that a transaction demand is

interest elastic as opposed to the interest inelasticity belief of Keynes.
12
On the base of inventory theory approach, Baume analyzed the interest
elasticity of money demand. He also analyzed the speculative motives of
analysis of Keynes in relation to uncertainty and risk aversion of
economic agents in the bond market. Tobin in brought another theory,
which explains liquidity performance as a behavior towards risk
(S.Gahtak, 1995).

2.1.4 Determents of money demand theories

2.1.4.1 The demand for money by individuals
The determinant of the individual money demand can be derived
from the theory of asset demand. According to this theory individual
base their demand on assets based on three characteristics.

 The expected return from the asset

The theory of asset demand states that, other things equal people
prefer asset offering higher expected returns. Because an increase in
interest rate is arise in the rate return on less liquid assets relative to the
rate of return on money. Individual want to hold more of their wealth in
non money assets that pay the market interest rate and less their
wealth in the form of money if the interest rate rises. Generally, all else
equal a rise in the interest rate causes the demand for money to
fall.(Mithani,2004).

 The riskiness of the assets expected return

It is risky to hold money because a un expected increase in the price
of goods and services could reduce the value of your money in a term of

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the commodities consumed. Since interest paying assets such as
government bonds have face values fixed in term of money, however,
the same UN expected increase in price would reduce the real value of
those assets by the same percentages. Because in the riskiness of the
money cause an equal change the riskiness of bonds, changes in the
riskiness of holding money need not cause individuals to reduce their
demand for assets(Mithani,2004)

 The assets liquidity

The main benefit of holding money comes from its liquidity. An
individual’s need for liquidity rises when the average daily value of
the transaction rises.(Mithani,2004)

2.1.4.2 Aggregate money demand

Is the total money demand by all households and form’s in the
economy? Aggregate money demand is just the sum of the
economy’s individual money demand. The main factors affect it.
Real national income: when real national income (GDP)
rises more good and service are being sold in the economy. This
increase in the real value of transaction raises the demand for
money given the price level. Generally, if p is the price level R is the
interest rate and Y is real GDP, the aggregate demand for money
(Md) can be expressed as:
Md=p*L(R, Y)……2.3(Mankiw&scarth, 2002)
Exchange rate: the variation in the exchange rate can
generate currency substitution effect in which a key role is played
by investor’s expectation. According to the currency substitution
14
 literature, as a weak domestic currency develops expectation for
future deterioration, asset holders will respond by shifting some of
their port folio away from domestic currency in to foreign assets.
Interest rate: a rises in interest rate causes each individual
in the economy to reduce his or her demand for money. All else
equal, aggregate money demand falls when the interest rate rises.

The price level: if the prices level rise, individual holds weekly
baskets of goods and service. To maintain the same level of liquidity as
before the price level increase, they will therefore have to hold more
money.

2.1.5 Equilibrium in the money market

If Ms and money supply and Md is money demand, the condition for
equilibrium in the money market is:

Ms=Md………………………………………2.1

After dividing both sides of this equation by price level, we can

express the money market equilibrium condition in terms of aggregate
real money demand as:

Ms/p=L(R, Y)…………………………………2.2

Given price level (p) and output (y) the equilibrium interest rate is
the one at which aggregate real money demand equal to real money
supply. The market always moves towards an interest rate at which the
real money supply equals real money demand. if there is initially an
excess demand, it rises.(Mankiw&scarth,2002)

15
2.2 Empirical literature review
Money demand is one of the highly studied areas in macro
economics. In this section the empirical literature on money
demand function in the context of both developed and developing
economics will be reviewed.
(Daowitz & Elbadawi,1987)cited in kemal (2004) presented an
empirical analysis on the demand for money in Sudan using
annual data for the period 1956-1982the main determinant in the
model were income, the foreign exchange as pay to measures the
opportunity costs as holding foreign currency rather than domestic
money. It was found that in addition to income both the rate of
inflation and the rate of foreign exchange were significant
variables.
Recently (m.Fafoah, 2003) found that there is a strong co-
integration relation between the narrow and broad monetary
aggregates and the level of economic activity inflation and the
parallel market exchange premium for sirloin. According to
Fafoah, an empirical analysis the rate of inflation, the level of
economic activity and the exchange rate are significant movement
in the amount of domestic real money balance and the interest
rate has no any role in the domestic real balance. Fonfah also
conclude that the economic financial and institution from under
taken the country since 1989 do not preclude the estimation of a
reasonably stable money demand.
When we come to Ethiopia like other least developing
countries the empirical researches regarding to money demand
function are few in number compared to developed countries.

16
A different approach was made by stricken (1999) who discussed
the circumstances of the Ethiopia economy. A part from the
standard determinants of money demand, he specially focused on
a specific circumstance that characterized the Ethiopia economy in
the study period. In the paper he discussed the long run monetary
conditions in Ethiopia for the period 1966-1994, which covers
three decades. These decades come be characterize by large
political changes, leading to shock son income and population
growth and two series periods to drought. Both affected inflation
due to drops in rain fall might have long run monetary
consequances.Stricken found that even though there is a region
shift he find the stability of Ethiopia narrow money demand.

(Behailu,2003) estimated broad money with dependent

variable and real GDP; real effective exchange rate used as
independent variables and used annual data for the period 1967-
2002.According to Behailu,the rate of exchange and the level of
real GDP are significant movement in the amount of real money
balance. He found that real GDP is positively affected money
demand. But real effective exchange rate is negatively affected by
money demand.
2.2.1. An overview of historical development
Of money demand in Ethiopia
history teaches that in the axumite king Dom coins had been
minted and served as a means of exchange with the fail of the
kingdom, however, the coins were disappear from circulation and
since the various commodities like bas or salt (a mole) close beads

17
etc… had been used as a money in Ethiopia. The most important
and widely spread were salt during that time. Even after the
introduction of Maria Theresa in to Ethiopia salt continued to
exists as one the popular medium of exchange .In addition to
commodity money, metallic money like Maria Theresa, the coin of
Menelik ll, Haile selasie l, the lire the east African shilling and the
present type of coins have been serving as a medium of exchange.
(AyeleKuris, 2006)

the first national coin was minted by menelik ll

in1893.menelik’s coins was replaced by the new metallic system
coins issued in July 1933 bearing the image of emperor Haileselase
l. these were metal currencies based on cents or hundred part of a
dollar. Paper money was issued by the bank of Abyssinia in 1914
and again issued by the bank of Ethiopia in 1932.After this in 1945
that the Ethiopia government issued the new national currency
Ethiopia birrs.as the prior attempts provide the creation and
launching of the legal tender currency was a revolutionary
achievement (AyeleKuris, 2006).

18
 CHAPTER THREE
3 .DATA AND METHODOLOGY OF THE
STUDY
3.1 Type and source of data
The data used for this is collected from secondary sources. Data
obtained from different organizations like national bank of
Ethiopia(NBE),central statistical authority (CSA),ministry of finance and
economic development(MOFED) and World bank(WB).In this study
annual data from 1982-2014 is used.

3.2 Method of data analysis

Descriptive and econometrics methods used to analysis and
interpret the data are qualitatively and quantitatively. The prefer uses
both methods simultaneously, in descriptive method the analysis
development aggregate monetary in Ethiopia theoretically and in
econometric method analysis the relation between money demand
from independent variables. In the econometrics part after regress the
data the following tests were used.

3.2 Model specification

The theory of the demand for money raises a number of questions
but does not provide definite answers. It seems, therefore, that test of
theory need to be conducted. One way of approaching this is to use the

19
theories to draw up a list of variables that should be involved in any
equations to be tasted. (Keith Bain and peter Howells, 2003)

In Ethiopia the determinant of money demand are many, but for

the purposes of this study money demand is assume to be affected by
real GDP, the inflation rate, the exchange rate, and interest rate So the
money demand is a functions of the mentioned variable.

The quantity theory of money deals how much money demands or

holds for a given amount of aggregate income. And the theory is based
on velocity of money demand. Velocity of money is the average number
of price that a unit of currency is spent.

MV=PY ………………………………… (1)

Were V=velocity

P=price level

Y=real income

M=money supply

Mv=total spending

Py=nominal in come

From the above equation:

V=1/m*Py or m=1/v*Py

According to classicalist, velocity of money depends on

institutional and technological factors related to the paying behavior of
the people. This is constant in the short run because in the short run
technology does not change.

20
 Mdd=1/v*PY=kPy………………………………(2)

Mdd is quantity of money demands and k is reciprocal of velocity

Classicalist theory shows that money demand is not a function of

interest rate according to him money demand for transaction purpose
only.

Keynes money demand equation:

Mdd/p=f (I, y)……………………………………..(3)

Were i=interest rate

Mdd=nominal money balance

Mdd/p=demand of real money balance

Keynes says income is the important determinant and interest rate

affects through speculative motive.

Friedman also developed the above equation as:

Mdd=f (yp, rb-rm, re-rm)………………………… (4)

Were rb = expected return on money

rm = expected return on money

re=expected return on equity

Yp=permanent income

Mdd=money demand

He say when (expected return bond minus expected return on

money and expected equity minus expected return on money) raises the

21
expected return on money will fall. i.e. (rb-rm and re-rm) increase leads
to Mdd decrease.

Based on the above equation the study develops following model

Md=F (realGDP, INF, ER and R )…………………………..(5)

The equation is Ln Md=β0+β1LnRGDP-β2Lninf-

β3LnER-β4LnR+ei.
Were Md=money demand

RGDP=realGDP

ER=exchange rate

R=interest rate

𝜀i=error term

In prior, it is expected that the relationship between money

demand and real GDP is positive and between that of money demand,
inflation rate, exchange rate and interest rate are negative.

3.3.1 Explanation of variable and

Hypothesis
3.3.1.1 Dependent variables
The dependent variables in the model are money demand which
represents the demand for money in the economy. The money demand
use in this study is broad money demand which is the sum of narrow
money (currency circulation plus demand deposit) plus quasi money
22
(saving and time deposit). This is because when the economy is at
equilibrium money supply equals money demand. In the world of
junking (1999), broad money is both an asset that can be used for
translation purpose and an alternative store of value yielding interest
income balance. (Mankiw & scarth, 2002).

3.3.1.2 Independent variables

Explanatory variable for this study are:

RealGDP: real gross domestic (GDP) is a macroeconomic

measure of the value of output economy adjusted for price change (that
is inflation and deflation). The income and other variables that
measures the value of transaction emanates from role of money as a
medium of exchange.

The use of such variables well documented in the work of Keynes,

the Cambridge school and Baumol Tobin’s inventory theoretic model of
money demand(Mishkin,2004).In all work it is show that when real
income rises, individual demand for money in crease.

Inflation: it is sustained increase in the general level of

prices. A one of increase in the general price level or sustained increased
in just small number of price does not constitute inflation or in other
word inflation may be defined as a persistent fall in the purchasing
power of money. In this study inflation will be taken as the opportunity
cost of holding money. Money is only of the assets that are available to
the public. That is there are other assets that can yield a real rate of
return. Thus when individual decide to hold money they forgo the return
they could obtain by holding of other assets. In effect, the opportunity
23
cost rises, people change their port folio composition and reduce their
demand for money is negatively related to the opportunity cost
variables.

Exchange rate: the price of one country currently expressed

in another country’s currency. In other words, the rate which one
currency can be exchange for another. For example, the higher the
exchanged for one birr in term of one dollar, the lower the relative value
of the dollar. When we see the relationship of exchange rate with that
of money demand, it is negatively related. if the exchange rate rises
implies that the local currency depreciate by this case the people will
shift more domestic currency by foreign in order to increase the
purchasing power of improved goods and the peoples demand for local
currency that is birr decreases.

Interest rate: as the interest rate rise, people will try to

economize on cash holdings; they will also tend to reduce speculative
balances of cash since bonds now seen like very good investment.
Eventually the rate will rise high enough to that people will no longer be
trying to add to their cash balances by selling bonds. The demand for
money wills again equals the supply. There Will no longer be an excess
demand for bond, so the interest rate stop rising. The net effect of the
original excess demand for money will have been an increase in the rate
of interest. Money demand depends negatively on average interest rate
due to speculative concerns. (Taiwo, 2012)

3.4 Econometrical testes

24
 Test for stationary:-one of the classical liner regressions
is that the series should be in order to estimate on the base of ordinary
least square (OLS) procedure. A is said to be stationary if its mean and
variance are constant over time and the value of the variance between
two time period depends only on the distance or lag between the two
time period and on the actual period at which the covariance is
computed.(Gujarati,2004)

E.g.: in a simple regression model

YT=pyt-1+ut…………………………………………………….eq.1

Were YT is the variable of interest is time index, p is coefficient, Ut

is error term. A unit root is present if p=1, the model would be non
stationary in this case. (Bender, 2015)

Empirical studies usually use the test ADF. For this study it will
employ ADF test and applied the test to each variable that will be used
in the analysis.

Test and correction for Hetroscedasticity: One

of the main assumptions for the OLS regression is the homogeneity of
the variance of the residuals for the model is too well-fitted. If this
assumption is not satisfied there is Hetroscedasticity. This problem can
arise as a result of the presence of outlier, data collecting techniques
and others.

Hetroscedasticity does not destroy the unbiasedness and

consistency properties of the OLS estimators, but they are no longer
efficient, not even asymptotically (i.e., large sample size).

25
 In order to ensure that the residuals are randomly dispersed
throughout the range of the dependent variable, we are going to use
the Hetroscedasticity test. The variance of the error should therefore be
constant for all values of the dependent variable. In the presence of
Hetroscedasticity, the distribution of the OLS parameters is no longer
normal. Hetroscedasticity is tested in this study using the Breusch-
pagan Godfrey test. The decision rule is to reject the null hypothesis if
the probability of the F-statistic and observed R2 less than 0.05,
meaning Hetroscedasticity is present. On the other hand, if the
probability of the F-statistic and observed R are greater than 0.05, we
do not reject the null hypothesis, implying that there is no
Hetroscedasticity. As such, errors are Homoscedasticity.

Test for autocorrelations: the term autocorrelation

may be defined as correlation between members of series of
observation ordered in time(as time series data) or space as in cross
sectional data ) In the regression context, the classical linear model
assumes that such autocorrelation does not exist in the disturbance Ui
(Gujarati,2004). To test autocorrelation the researches will use the
Durbin Watson d statistics test or d- test.

D ≈ 2(1−𝜌)…………………………………eq.2

But since−1 ≤ 𝜌 ≤ 1, 𝐸𝑞. 1 implies that 0≤ 𝑑 ≤ 4 it is apparent

from Eq.1 that if 𝜌 = 𝑜, 𝑑 = 2; that is if there is no serial correlation (of
the first– 𝑜𝑟𝑑𝑒𝑟),d is expected to be about 2.

Therefore as a rule of thumb, if d is found to be 2 in an application,

one may assume that there is no first – 𝑜𝑟𝑑𝑒𝑟 auto correlation, ether
positive or negative. if 𝜌 = +1, indicating perfect positive correlation in

26
the residuals, d≈ 0. There fore,the closer d is to 0,the greater evidence
of the positive serial correlation.(Gujarati,2004).

Test for Multicollinearity: originally it meant the

existence of a perfect or exact linear relationship among some or all
explanatory variable of regression model. In the research, to test
whether there is Multicollinearity or not the researcher used VIF and
Tolerance (TOT).

The formula for computation of VIF and TOL as presented by

Gujarati (2004) is s:

VIF=1/(1-rij2

TOT=1/VIF

27
 CHAPTER FOUR
4. RESULTS AND DISCUSSION
4.1. Descriptive analysis
4.1.1. Development of monetary aggregate in
Ethiopia
Monetary policy is implemented by both developed and developing
countries; with the goal of achieving the objectives of full employment,
price stability, economic growth and other macroeconomic objectives.

The Ethiopia economy like other less developed countries is

characterized by the existence of economic dualism. I.e. the existence of
modern and traditional sector is associated with the miniaturized
economic activities. Monetary development is usually explained by
growth in domestic liquidity, excess reserve of commercial banks and
deposit mobilizations. (S.Gahtak, 1995)

The command economy that the country followed during the

military regime there direct control on money and its components. In
line with the socialist ideology the government nationalized all private
banks.

28
Table 4.1 Growth rate of MD and R GDP

Year MD Real GDP Exchange

Growth Growth rate
rate Rate
1982 10.29 0.92 20.7
1983 14.46 8.23 20.7
1984 9.74 -2.84 20.7
1985 17.13 -11.14 20.7
1986 11.39 9.66 20.7
1987 5.63 13.85 20.7
1988 11.08 0.50 20.7
1989 15.57 -0.36 20.7
1990 19.87 2.72 20.7
1991 15.93 -7.13 20.7
1992 15.22 -8.67 20.7
1993 8.78 13.14 5
1994 23.17 3.18 5.465
1995 9.03 6.12 6.158
1996 9.05 12.42 6.352
1997 19.83 3.13 6.709
1998 -1.09 -3.45 7.116
1999 13.71 5.16 7.942
2000 13.07 6.07 8.217
2001 9.68 8.301 8.457
2002 15.93 1.51 8.568
2003 12.44 -2.16 8.6
2004 19.26 13.57 8.636
2005 18.59 11.818 8.666

29
2006 19.99 10.83 8.699
2007 22.21 11.45 8.966
2008 23.39 10.78 9.6
2009 24.29 8.802 11.78
2010 39.19 12.55 14.41
2011 33.49 11.17 16.9
2012 22.09 8.65 17.7
2013 22.99 10.49 18.24
2014 23.99 21.29 19.53
Source: own Computation.

Based on the above table during Dergue regime i.e. 1982-1990, the
average annual growth rate of money demand was 12.79 percent per
annum. The average growth of MD during transitional government and
the beginning of EPDRF i.e. 1990-1999 was 12.62 percent per annum. By
the time of 2000-2008, the average growth rate of MD was 17.17.this
result shows that during the dergue regime average growth rate was
higher than transitional government and beginning of EPDRF. But it
starts to rises highly after the EPDRF stood its ground in the year of
2000 onwards.

By the end of 2009 the money demand grows by 24.29 percent

greater than 23.39 percent rise in 2008.this optimistic monetary policy
was consistent with NBE primary objective of maintaining price and
exchange rate stability and creative conductive environment for
sustainable economic growth. As monetary indicators a shows that,
growth in money demand was exclusively attributed to the increase in
domestic credit particularly to the nongovernmental sector.

As the end of 2010, growth of money demand reached 39.19 percent,

compared with the period of last year it is large. But in 2012 it is

30
decrease to 22.09 percent as compared to the past fiscal year growth
rate of money demand. And after 2012 again after 2012 again it starts
to rise reached 23.99 in 2014 year.

4.1.2 The factor determine the money demand

in Ethiopia
1. Economic growth (RGDP)
The classical economists argue that people are motivated to hold
money for its utility as a medium of exchange. Thus according to this
theory demand for money for money is determined by the income of the
individuals. Thus, it is reasonable to take gross domestic product as
money for scale variable that each up the transaction motives of the
demand for money.

Table 4.2 Average growth rate in various year

intervals
Year RGDP MD Agricultural Industrial Service
sector sector sector
1982- 1.44 13.10 0.6 2.5 3.65
1991
1992- 4.54 12.04 2.5 7.1 7.8
2001
2002- 10.22 22.90 7.1 9.21 14.06
2014
Source: own computation, using data from MOFED

31
 The macro economic performance of the military regime of the derge
was unsatisfactory. Over this period, real GDP grew on an average rate
of 1.44 percent per annum against population growth rate of 2.6
percent indicating declining of per capital income. This weak result is
attributed among other things, to the poor performance the agriculture
sector and huge military spending. During the same period the growth
of money demand or broad money were about 13.1 percent.

With the change of government in May 1991 there comes a radical

change in economics orientation away from the “socialist” regime of
the derge in to the more liberal capitalist system of the free market. In
mid 1992, the government becomes implementing significant economic
reform aimed at stabilizing the economy and deregulating economic
activity.

The economic reform measures could be argued that the economy is

recovering with average growth rate of real GDP for the period 1992-
2001 reaching about 4.54 percent. The situation of highs monetary
policy changed at the beginning the border conflict with Eritrea and
money demand start to decline considerably. In 1998, the money
demand growth rate percent -1.09 per annum compared with a GDP
growth -3.45 percent. The conclusion of the war saw a reversal of this
high growth of money demand relative to domestic income during 2007
and 2008 fiscal year money demand increase from 22.21 percent to
23.39 percent per annum and the real GDP growth rate are 11.45
percent and 10.78 percent respectively of the mentioned year. In 2013,
realGDP growth rate was 10.49 percent slightly higher than 8.65
percent last fiscal year and also during 2014 the growth rate of real
GDP reached 21.29 percent per annum.

32
 The performance of the economy as can be represented by the
country gross output is positively related to the money demand. This is
because in the more of Keynes, the Cambridge school invents the
theoretic model of money demand, shows that when income rise,
individual demand for money increases.

2 The exchange rate

In an open economy, individuals can choose to hold wealth in a port
folio of different assets such as domestic money, domestic bonds and
forgoing money so that the exchange rate of major trading partner is
like to become an important of domestic port folios.thus,the exchange
rate measures the rate at return on foreign money. The variation in the
exchange rate can generate a currency substitution effect in which a
key role is played by investor’s expectation. According to the currency
substitution literature, as a weak domestic currency develops
expectation for future deterioration, assets holders will respond by
shifting some of their port folio away from domestic currency in to
foreign assets.

So if depreciation of domestic currency increase in exchange rate

induces a decline in money holding by domestic
residents.(Nardiri,1981).In Ethiopia the demand for money also depends
on the variation in exchange rate because of the Ethiopia economy
heavily depends on external resource and funds. Therefore, it is very
important to over view the exchange rate situation of Ethiopia under
the study period.

Stable exchange rate is one of monetary policy which brings

macroeconomic stability. The exchange rate of the Ethiopia economy

33
(birr) has been administratively fixed at 2.07 per us dollar for over three
decades.(Befikadu,1991)

Since the beginning of structural adjustment program, towards the

end of 1992, the government has taken a sense of reform measures and
policy changes. The policy change managed floating type of exchange
rate system is being implemented now.

When we see the relationship between exchange rate with that of

money demand, it is negatively related. If the exchange rate rise implies
that the local currency depreciates by this case the people will shift
more domestic currency by foreign order to increase the purchasing
power of imported goods.

In Ethiopia the exchange rate is negatively related with the money

demand for instance during the period 1992 the exchange rate is 2.8
percent increase in 1993 to 5 percent but in the same year the demand
for money decrease for 15.22 percent to 8.78 percent it is because of
depreciation of domestic currency by the case of increased exchange
rate. Between the periods of 1997-2003 the exchange rate rises from
6.709 to 8.6 percent and the money demand growth demand rate fall
from 19.83 to 12.44 percent per annum.

During the period of 2010-2014 the growth of the demand for

money is depreciated from 39.2 to23.9 percent. But in the same year
the exchange rate rise from 14.4 to 19.53 percent respectively.

The above table analysis shows that money demand has negatively
relationship with exchange rate.

4.2 Econometrics analysis

34
 The Stata result of original data shows that real GDP has
positive and inflation rate, exchange rate and interest rate has
negatively relationship with that of broad money demand.

1. Test for stationary

There are different ways of testing stationary. In this
paper, the two widely applicable (and most available in
statistical soft ware) test of unit root, namely the Dickey-Fuller
(DF) and Augmented Dickey Fuller (ADF) is used. It is, known
that most time series variables are non stationary at level.
Differencing the respective variables and running regression on
the same can handle the non stationary problem.

I. Augmented Dickey Fuller Test at level

Table Dickey Fuller (DF) test for stationary at
level
VARIABLES 1% 5% 10% Test P value
critical critical critical statistic
value value value

LMD -3.702 -2.980 -2.666 4.671 0.023

LRGDP -3.702 -2.980 -2.666 3.764 0.015

LINFI -3.750 -3.000 -2.630 -3.436 0.004

LER -3.702 -2.980 -2.622 2.455 1.000

LR -3.750 -3.000 -2.630 -2.374 1.000

Source: own survey 2016

35
 As the Stata result of a Augmented Dickey Fuller (ADF) test at level
shows broad money demand (LMD) and real GDP are variable are
stationary at all (1%, 5%, 10%) critical values. but inflation rate (LINFL)
is stationary at (5%, 10%) and interest rate (LR) and exchange rate (LER)
are not stationary at 1%, 5%, 10%, and at all critical values.

ii. Augmented Dickey Fuller at first differenced

But when the first difference of the variables taken and test its
stationary using Augmented Dickey- Fuller (ADF) test inflation (DLINFL)
interest rate (DLR) stationary and real GDP (DLRGDP) at all critical
values (1%, 5%, and 10%). But exchange rates (DLER) and Broad money
demand (DLMD) is stationary at second difference (1%, 5%, 10 %,).

Table 4.4 Augmented Dickey Fuller (ADF) test

for first differenced of data
Variables 1% critical 5% critical 10% Test P value
value value critical statistic
value
DLMD at -3.709 -2.983 -2.623 -6.312 0.027
second
difference
DLRGDP -3.709 -2.983 -2.623 -4.692 0.0060
at first
difference
DLINFL at -3.709 -2.986 -2.623 -6.602 0.000
first
difference
DLER at -3.716 -2.986 -2.624 -5.487 0.015
second
36
difference
DLR at -3.709 -2.983 -2.623 -5.106 0.000
first
difference
Source, own survey, 2016

2. Test and correction for Hetroscedasticity

One of the main assumptions for the OLS regression is the
homogeneity of variance of the residuals for the model is to well-
fitted. if this assumption is not satisfied there is Hetroscedasticity.
This problem can arise as a result of the presence of outlier, data
collecting techniques and others.
Hetroscedasticity does not destroy the unbiasedness and
consistency properties of the OLS estimators, but they are no longer
efficient, not even asymptotically (i.e., large sample size).
In order to ensure that the residuals are randomly dispersed
throughout the range of the dependent variables, we are going to
use the Hetroscedasticity test. The variance of the error should
therefore be constant for all values of the dependent variables. In
the presence of Hetroscedasticity, the distributions of the OLS
parameters are no longer normal. Hetroscedasticity tested in this
study using the Breusch-Pagan Godfrey test. The decision rule is
rejecting the null hypothesis if the probability of the F-statistic and
observed R2 are less than 0.05, meaning Hetroscedasticity is present.
On the other hand, if the probability of F-statistic and observed R are
greater than 0.05 we do not reject the null h hypothesis, implying
that there is no Hetroscedasticity. As such, errors are
Homoscedasticity. The test results are shown:

37
 Breusch-Pagan/cook-Weisberg test for
Hetroscedasticity
Ho: Constant variance
Variables: fitted values of md
Chi2 (1) =5.53
Pro > chi2 =0.187
From this we can conclude that there is no Hetroscedasticity
problem because the probability of F-statistics and observed R2 are
greater than 0.05.
3. Autocorrelation test
The most celebrated test for detecting serial correlation is that
developed by statisticians Durbin and Watson. It is popularly known as
the Durbin-Watson d statistic. A great advantage of the d statistic is
that it is based on the estimated residuals, which are routinely
computed in regression analysis.

Using the rule of thumb discussed in chapter three when Durbin-

Watson d statistics test is applied of the original data it comes out as
follows

Durbin-Watson d statistic (5, 33) =0.7875009

This shows that because the value of d is close to 0 than the

original data has a problem of positive autocorrelation. But when the
stationary of the first difference data using Durbin-Watson d statistic
applied the Stata result shows as follows:

Durbin-Watson d-statistic (5, 31) =2.407004

38
This result shows that there is no serial correlation because it is found to
be closer to 2 in an application.

4. Test for multicollinearity

As a rule thumb the largest the value of VIF or if the VIF of the
variable exceeds 10 and the value of TOL is greater than 90% (percent),
the more will be the degree of co linearity of the variable with the other
repressors’. On the other hand the value of TOL (tolerance) is less than
90% and VIF is less than 10, the greater the evidence that variable is not
collinear with other regressions. (Gujarati, 2004)

Table 4.5 Test for Multicollinearity

Variable VIF 1/VIF

DLER 1.36 0.736410
DLINF 1.32 0.793745
DLRGDP 1.22 0.818364
DLR 1.14 0.876279
Mean VIF 1.25 ---------

39
FROM the above table the value of VIF for the independent variables
are less than 10 and the value of the tolerance are less than 90% .from
this, we can conclude that there is no problem of Multicollinearity.

4.3. Estimation Results and Analysis

The Stata result of first difference shows that real GDP has positive
relationship. And inflation rate, exchange rate, and interest rate have
negative relationship with that of broad money demand.

Table 4.6 Stata results first and second differenced

Source | SS df MS Number of obs = 7

---------+------------------------------------------------ F (4, 2)=2.78

Model | 0.025841333 4.006460333 Prob >F =0.2815

Residual |0.004645315 2.002322658 R-squared =0.9476

---------- + ---------------------------------------------------- Adj Squared =0.9429

Total 030486648 6.005081 0.04819

40
DLMD COEF STD.ERR. T P|T| 95%
CONF.
INTERVAL
DLRGDP 1.241416 .6210326 8.57 0.00 -1.108584
4.235592
DLINF -1.59356 .0168307 2.52 0.018 -.0493002
.0955329
DLER -0.626463 .5153178 8.94 0.000 -3.342879
1.091588
DLR -0.15707 .0107206 1.54 0.001 -.029612
.0626423
CONS -.1895583 .0341107 2.15 0.041 -.0040238
.2975568
Source own survey, 2016

In the table the p-value shows that all of my independent variables

are significant. And realGDP, exchange rate and inflation rate have
strong relationship with money demand and both variables are the
main determinants of money demand. Exchange rate also the
determinant of money demand. But it influence money demand is less
than from that of the above mentioned determinants.

41
 So in my case because the residual of the residual of the original
data is non stationary I can take the first difference regression results
for the data analysis.

From chapter three the model specification

was specified as

LnMd =B +B1LnGDP –B2lninf –B3lnER –B4LnR

+ei
So specifically the result the coefficient of the determinant that is B0, B1,
B2, B3, B4, ARE known based on the result the model becomes

LnMd= - 0.1895583+ 1.241416LnRGDP –

1.593564 Lninf – 0.6264634LnER –
0.15707LnR + ei
T-value (2.15) (8.57) (2.52) (8.94) (1.54)

R 2= 0.9429 F( 4, 2 ) =2.78

42
R2 the higher value of R the higher fitness of the model (Guajarati,
2004). From the Stata the result the value R in which interred as the
explanatory variable explains about 94.29 % of the variation in money
demand. The remaining 5.71% of the money demand is explained the
variable which is not included in the model.

If the rate of real GDP increase by one percent other thing remain
constant, the money demand will increase by 1.241416percent. We
know that as GDP grows the per capital income of individuals will
increase this lead to the rise of money demand. The income and any
other variable that measures the value of the transaction emanates
from roles of money as a medium of exchange. The use as such a
variable is well documented in the works of Keynes, the Cambridge
school and Baumol Tobin inventory theoretical model of money
demand. In all the works it is shown that when real income raises
individual demand for money increases.

On the other hand if the rate of inflation rises by one percent other
thing remain constant, the demand for money will fail by 1.593564
percent. Since holding of money for a long period of time is opportunity
cost, peoples demand for money as inflation rises will fail. The use as
such a variable is documented in the work of kenyes. As expected
inflation increases individual reduce their holding of money. Thus,

43
inflation rate and money demand have negative relationship the other
variable is exchange rate.

From the table we can see that as the rate of exchange rate rises by
one percent other thing remain constant, the demand for money will
decrease by 0.6264634 percent. That is the depreciation of the currency
by one unit will result a decline in the demand for money by 0.6264634.
The use as such a variable is documented in work of Keynes. The
exchange rate increases individual money demand decrease.

Finally, interest rate is found to explain inversely related with

money demand as theoretically expected. The rate of the interest
increase by one percent other thing remain constant, the demand for
money fall by 0.15707 percentage. The use as such a variable is
documented in Keynes, and Freidman theory. In all the works it is shown
that then interest rate raises individual money demand decrees.

44
CHAPTER FIVE
5. CONCLUSION AND RECOMMENDATION
5.1 conclusions
As the researcher tried to indicate in the outset, the main objective
of the study is to identify the determinants of money demand in
Ethiopia, knowing this determinant is very crucial for policy formulation
and its effectiveness.

The paper has studied developments in the macroeconomics

situation and financial system that are relevant for the money demand
in Ethiopia.

Monetary development is usually explained by growth in domestic

liquidity, excess reserve of commercial banks, deposit mobilization and
development in monetary aggregates. To this effect it has attempt to
explain growth in money supply and development in deposit
mobilization of a banking system as indicators of monetary
development and it has attempted to the factor that determine the
demand for money in Ethiopia.

In formulating the money demand function, the paper has tried to

include real GDP, inflation rate, exchange rate, and interest rate that
affect the money demand and supply and also the monetary
development of the country. The real GDP positively related with the
demand for money. The inflation rate and exchange rate are the
variable that affects the demand for money negatively.

45
 The econometrics part result showed that the effect of real GDP on
money demand is very high relative to other variables and the inflation
rate is low. In general the paper found that in Ethiopia money demand
is affected by different factors but the main determinant are realGDP,
inflation rate, exchange rate and interest rate.

5.2 Recommendations
The main intent of this paper is to identify the main determinant
of money demand in Ethiopia. The result of the analysis showed that
exchange rate, inflation rate, realGDP, and interest rate are statistically
significance.

To achieve the comprehensive reform program of the growth and

transformation plan (GTP) and changes in macroeconomic policies
based on this result the following policy implication may be drawn.

 The growth in the saving deposit has resulted in the

accumulation of excess liquidity in bank. Probably the rise the
lending rate might have contributed to excess liquidity. A rising
lending rate carries the possibility of crowding out of the
private sector can be either directly or indirectly. There for, the
government should reduce both deposit rate and lending rate.
 The other finding of this paper is that the rate of inflation plays
significant role in shaping the behavior of agents. Hence the
authority has to target inflation to ensure macroeconomic
stability.
 Despite the fact that the deprecation of exchange rate should
have helped to improve the competitive of Ethiopia export in the
international market. There for, so as to develop export sector

46
 other measures beside deprecation of exchange rate have to be
taken like introducing import substituting industry and developing
the capacity of small scale industries. Otherwise only deprecation
of exchange rate will not be effective because it will affect money
demand in the long run negatively.
 Strength supervision and regulation of financial institution;
 Creating the opportunities for banks to allocate their resources on
economic principles in view of sterilizing the structure liquidity
problem.
 Maintain creditability, transparency and public confidence in the
public confidence in the financial system by creating a sound and
competitive financial market; and
 Deepening the financial sector liberalization to enhance
competition in the banking sectors.

47
 Bibliography
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AyeleKuris. (2006). the Ethiopia economy, 2nd edition. Addis Ababa.

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Befikadu. (1991). “Annual report on Ethiopia economy “vol.l. Addis

Ababa.

Behailu. (2003). the demand for money and monetary policy. Addis
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Bender. (2015, April 20). Wikipedia. Retrived from Wikipedia; Google

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Damowitz & elbadawi. (1987). An Error Correction Approach to money

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Gujarati, D.N.(2004). Basic Econometrics. United State Agency

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Haile kibert. (2003). Economic Reform and Stability of the Money

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Jingan. (1983). Theory of Money Demand.

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M.Fafoah. (2003). The Demand for Money and the Implication for
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Mahaduk, D. (2013, may 21). Researchgate.net. Retrieved from

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N.G.D. (2004). Basic Econometrics. United States Military Agency

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PeterBofinger. (2003). Monetary Policy, Goals, Institutions State and

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Unpublished MSC Thesis School at Araavates Studies AAU.

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49
APPENDIX
Appendix 1

Macroeconomic data from 1982-2014

Year Md RGDP INF ER R

1982 10129.6 40834.8 7.774 20.7 6
1983 13019.1 45391.7 3.569 20.7 6
1984 13793.9 42351.8 -0.334 20.7 6
1985 14973.1 36476.2 18.403 20.7 6
1986 13504.5 40678.1 5.55 20.7 6
1987 8966.6 47267.2 -9.146 20.7 4
1988 19736.2 47336.3 2.206 20.7 4
1989 20634.8 47694 9.633 20.7 4
1990 24883.7 49329.1 5.206 20.7 4
1991 29734.1 48031.7 20.689 20.7 4
1992 34298.3 45042.2 21.019 20.7 4
1993 39060.1 50097.8 9.99 5 10
1994 42883.2 50478.2 1.166 5.465 10
1995 52802.7 52504 13.354 6.583 1o
1996 59379 59194.9 0.919 6.3517 10
1997 63761.8 61888.4 -6.42 6.7093 7
1998 70122.6 59748.2 3.6 7.1159 6
1999 70348.6 62832.6 4.772 7.9423 6
2000 78917.2 66648.3 6.159 8.2173 6
2001 90408.8 72181.1 -5.214 8.4575 6
2002 99606.7 73274.4 -7.224 8.4678 3
2003 111624.9 71690.9 15.061 8.5997 3
2004 125416.9 81421.1 8.616 8.6356 3
2005 147583.8 91044.1 6.842 8.6664 3
50
2006 174421.3 100908.4 12.255 8.9986 3
2007 208570.6 112468.5 15.838 8.966 3
2008 253524.7 124602.2 25.316 9.5997 4
2009 310413.6 135557.2 36.399 11.778 4
2010 456878 152404.7 2.786 14.41 4.5
2011 566788 169641.5 18.111 16.899 5
2012 676698 186878.3 34.3 17.7 5
2013 701820 618328.3 34.1 18.3 5
2014 7371o8 679765.8 13.5 19.1 5
Source; national bank of Ethiopia (NBE) organization

Appendix 2
VARIABLES 1% 5% 10% Test P value
critical critical critical statistic
value value value

LMD -3.702 -2.980 -2.666 4.671 0.023

LRGDP -3.702 -2.980 -2.666 3.764 0.015

LINFI -3.750 -3.000 -2.630 -3.436 0.004

LER -3.702 -2.980 -2.622 2.455 1.000

LR -3.750 -3.000 -2.630 -2.374 1.000

51
Variables 1% critical 5% critical 10% Test P value
value value critical statistic
value
DLMD at -3.709 -2.983 -2.623 -6.312 0.027
second
difference
DLRGDP -3.709 -2.983 -2.623 -4.692 0.0060
at first
difference
DLINFL at -3.709 -2.986 -2.623 -6.602 0.000
first
difference
DLER at -3.716 -2.986 -2.624 -5.487 0.015
second
difference
DLR at -3.709 -2.983 -2.623 -5.106 0.000
first
difference
|

Table 4.6 Stata results first and second differenced

Source | SS df MS Number of obs = 7

---------+----------------- -------------------------- F(4, 2)=2.78

Model | 0.025841333 4.006460333 Prob >F =0.2815

Residual |0.004645315 2.002322658 R-squared =0.9476

---------- + ----------------------------------------- Adj Squared =0.9429

52
Total 030486648 6.005081 0.04819

DLMD COEF STD.ERR. T P|T| 95%

CONF.
INTERVAL
DLRGDP 1.241416 .6210326 8.57 0.00 -1.108584
4.235592
DLINF -1.59356 .0168307 2.52 0.018 -.0493002
.0955329
DLER -0.626634 .5153178 8.94 0.000 -3.342879
1.091588
DLR -0.15707 .0107206 1.54 0.001 -.029612
.0626423
CONS -.1895583 .0341107 2.15 0.041 -.0040238
.2975568
Source own survey, 2016

53
Variable VIF 1/VIF
DLER 1.36 0.736410
DLINF 1.32 0.793745
DLRGDP 1.22 0.818364
DLR 1.14 0.876279
Mean VIF 1.25 ---------
Breusch-Pagan/cook-Weisberg test for
Hetroscedasticity
Ho: Constant variance
Variables: fitted values of md
Chi2 (1) =5.53
Pro > chi2 =0.187

Durbin-Watson d-statistic (5, 31) =2.407004

54
55