INVESTIGATING THE EFFECTS OF FINANCIAL INNOVATIONS ON THE DEMAND FOR MONEY IN MALAYSIA USING THE ARDL APPOACH TO COINTERGRATION

Payam MOHAMMAD ALIHA

Ph.D candidate, National University of Malaysia (UKM), Malaysia

payammaliha@gmail.com

Tamat SARMIDI

Associate Professor Dr. at Faculty of Economics and Management, Universiti Kebangsaan Malaysia (UKM), Malaysia

tamat@ukm.edu.my

Abu Hassan SHAAR

Professor Dr. at Faculty of Economics and Management, Universiti Kebangsaan Malaysia (UKM), Malaysia

ahassan@ukm.edu.my

Fathin FAIZAH SAID

Dr. at Faculty of Economics and Management, Universiti Kebangsaan Malaysia (UKM), Malaysia

fatin@ukm.edu.my

Abstract

Money demand function plays a vital role in monetary policy formulation. Over the years, several countries have experienced growth in financial innovation which has implications for monetary policy. This paper estimates the relationship between financial innovation and money demand in Malaysia with a focus on payment instruments (PI), payment systems (PS) and payment channels (PC) using the ARDL approach to cointegration between 2008 Q1 to 2015 Q4. This paper adopts the bounds testing procedure developed by Pesaran et al. (2001) to test the stability of the long-run money demand and determine the short-run dynamics for Malaysia. The empirical evidence points to the fact that while innovation in the Malaysian financial system have not ruled out the existence of stable long run money demand relationships as attested to by QUSUM Test, they (except for PS) fail to pass the Bound Test meaning that there is no evidence for a long-run association between variables. Therefore, for PI and PC, we cannot proceed to the next step. For PS, the estimated coefficient for the error correction term is not significant which means that there is no adjustment towards long-run equilibrium. In other words, disequilibrium between money demand and independent variables is not corrected over time and it actually diverges rather than converge.

Keywords: Money demand, Financial innovations, Stability, ARDL, Cointegration

JEL classification: C13, C40, C51, E40, E44

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