Inflation-rate volatility and money demand: Evidence from less developed countries

Theory suggests that inflation-rate volatility should affect real money balances, although there is ambiguity about the sign of the effect. This paper uses techniques designed to accommodate nonstationary data, and the major results show that increases in the volatility of domestic inflation exert a significant negative effect on money demand in both the short run and the long run in each of the eight less developed countries (LDCs). Nonstationarity in the demand for money in most of our samples is resolved only when a proxy for inflation-rate volatility is included as a regressor. The interest rate variable, ignored in several LDC studies, exerts a statistically significant long-run effect on real money balances of all eight LDCs, except for Kenya.