Interest rate sensitivity of demand for money and effectiveness of monetary policy: fresh evidence from combined cointegration test and ARDL approach

The money demand function (MDF) is an inevitable monetary policy tool utilized to examine the impact of the monetary sector on the real sector. However, fnancial innovation and institutional changes in the late 1970s and early 80s have afected the money demand stability. Henceforth, less importance has been given to money in the new Keynesian monetary policy framework. In the preceding backdrop, the present study examines money demand stability by highlighting the interest rates sensitivity as an inevitable issue while estimating diferent monetary aggregates. To this end, we utilize the combined cointegration, autoregressive distributed lag model, and Hansen’s instability test. The study fnds cointegration among variables under consideration and a well-specifed MDF, implying a stable short-and longrun money demand relationship in India for the period 1996:Q2 to 2016:Q3. Henceforth, the stable money demand has policy implications in terms of focusing monetary aggregate as an essential indicator or information variable to maintain the price stability under India’s current fexible infation-targeting framework.