Impact of Foreign Exchange Rate Volatility on Money Demand in Pakistan: An Empirical Analysis

Abstract

The primary aim of this study is to examine the influence of foreign exchange rate volatility on money demand in Pakistan. To achieve this objective, the study utilizes the disaggregate expenditure approach to construct the money demand function. Empirical estimation is carried out using the autoregressive distributed lag approach to investigate the co-integration among various factors including money demand, exchange rate volatility, investment expenditure, consumption expenditure, government expenditure, and inflation. The findings from the long-run analysis reveal several significant relationships. Firstly, household consumption expenditures, investment expenditure, and inflation exhibit a positive and significant association with money demand in the context of Pakistan. This suggests that as household consumption and investment expenditure increase, along with inflation, there is a corresponding rise in the demand for money within the economy. Conversely, the long-run results pertaining to government expenditures and exchange rate volatility demonstrate a negative and significant impact on money demand. This implies that higher levels of government spending and greater volatility in the foreign exchange rate are associated with a decrease in the demand for money in Pakistan. These findings highlight the complex interplay between various economic factors and their impact on money demand in the Pakistani context. Understanding these relationships is crucial for policymakers and economists in formulating effective monetary policies and strategies to manage and stabilize the economy.