Money demand and financial liberalization in Indonesia

This paper offers a new strategy to investigate the effects of financial liberalization on the demand for money. This strategy explicitly accounts for the impact of financial liberalization by including a proxy for this process in the money demand equation. The long-run demand for money is estimated using the procedure developed in [Pesaran, M. H., Shin, Y., & Smith, R. J. (2001). Bounds testing approaches to the analysis of level relationships. Journal of Applied Econometrics 16, 289-326]. This procedure represents an alternative to standard cointegration tests, which we argue may be inappropriate in the presence of financial liberalization. Focusing on Indonesia, we find that financial liberalization plays a key role in determining money demand and its fluctuations.