Demand for Demand Deposits in Nigeria

34 Pages Posted: 12 Jan 2006

Date Written: January 2006

Abstract

This paper extends the empirical research strategy adopted for modeling demand for M1 in Nigeria in Teriba (2006a) to one of its two sub-components, demand deposits (DD). All of our findings for M1 stand up for DD, with one important addition: demand deposits respond significantly to foreign interest differentials in both the long run and the short run. Foreign deposits are therefore substitutes to domestic deposits in Nigerian money-holders' portfolio. Again, as with M1, we establish the strong relevance of interest rates in Nigerian DD demand models. The rate of inflation had no place in the long run demand for DD models recovered in this study. The exchange rate or its rate of depreciation also plays no role whatsoever in models. We recover economically sensible, econometrically sound, and policy relevant long run and short run empirical models of the demand for DD in Nigeria. We find that the assumed long run relations hold between DD, total domestic expenditure, its deflator, two domestic interest rates, and a foreign interest differential. We establish that domestic absorption, not gross domestic product, is the relevant measure of transactions in the model for DD in Nigeria. We also confirm that the deflator for domestic absorption, not consumer price index, is the relevant proxy for the general price level in the DD model. We document significant 'own' and 'cross' price effects in the long run relations. The two domestic interest rates that entered the relations were the three-month time deposit rate and the Treasury bill rate. The time deposit rate mimicked the 'own-rate' of money in the equation, while the treasury bills rate captured the domestic 'cross-price effect', representing the domestic opportunity cost of money holding. The foreign interest differential enters the model to capture the foreign cross-price effect, or foreign opportunity cost for money holding. Deletion of any of the two domestic interest rates in the long run models led to loss of the cointegrating relationships. Not only is a meaningful cross rate effect recovered only when the own rate is allowed for, both must be included for cointegration to occur. Deletion of the foreign interest differential similarly led to a loss of the cointegrating relationships. To be valid, therefore, empirical models for DD in Nigeria must not only include two domestic interest rates, as proxies for the own-rate and the opportunity costs, but also one foreign interest differential, to capture the cross border asset substitution effect that is evidently pervasive in Nigeria.

Keywords: Money demand, demand deposits (DD), narrow money, interest rates, own-price, cross-price, own rate, opportunity cost, transaction shocks, portfolio shocks, emerging markets, Nigeria

JEL Classification: C51, E41, O16

Suggested Citation

Teriba, Ayo, Demand for Demand Deposits in Nigeria (January 2006). Available at SSRN: https://ssrn.com/abstract=874450 or http://dx.doi.org/10.2139/ssrn.874450

Ayo Teriba (Contact Author)

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