Real Versus Nominal Adjustment Mechanism of the Malaysian Money Demand Function : Further Evidence

Abstract

This article investigates the issue of real versus nominal adjustment specifications in the Malaysian money demand function. Performance of both specifications was subjected to several tests, namely ; model specification ex-post forecasting ability and stability tests. Our results shows that under both specifications, the Malaysian money demand function for M1, M2 and M3 are not stable for the period 1962 – 1991. Our question is, does financial innovation during the period of 1979 – 1991 affected the stability of the Malaysian money demand function? A test on Gurley-Shaw hypothesis was done to answer the above question. However, our results suggest that financial innovation does not play a major role in affecting the Malaysian money demand function during the period under study. Nevertheless, the interest rate elasticities (for both short-run and long-run) has been declining over the period of 1979 – 1991, indicating the effectiveness of monetary policy as a policy tool.