IN SEARCH OF A STABLE NARROW MONEY-DEMAND FUNCTION FOR INDONESIA, 1970–2007

Abstract

This paper adopts the Johansen approach to cointegration to estimate a narrow money-demand function for Indonesia with annual data for the period 1970–2007. Empirical results suggest that there exists a cointegral relationship between real narrow balances, real permanent income and the deposit rate of interest. The recursive and rolling regression results suggest that the narrow money-demand function has remained largely stable irrespective of ongoing financial reforms in Indonesia since the late 1980s and/or financial crises in the late 1990s. The Quandt-Andrews breakpoint and the Hansen-Johansen stability tests results however suggest that the narrow money-demand relationship had a structural break in the early 1990s. This corresponds to a period of time when the banking and financial reforms in Indonesia took effect. The Chow breakpoint test results suggest that there was also a structural break in the money-demand relationship during the financial crises of the late 1990s.