Effects of exchange rate on money demand: Turkey example

The stability of the money demand function and its determinants are of great macroeconomic importance for monetary authorities in monetary policy implementation. The stability of money demand also affects the effectiveness of monetary policy. In addition, the intermediate objectives of central banks may also change depending on whether the demand for money is stable or not. In an economy with stable money demand, the central bank may choose money supply as an intermediate target, while in an economy with unstable money demand, it may choose interest rate target. Therefore, various empirical studies have been conducted on whether the demand for money is stable or not. A significant number of studies for Turkey have found that the demand for money is not stable. The aim of this study is to investigate the determinants of exchange rate and money demand in Turkey, to investigate how exchange rate affects money demand and to contribute to the studies on money demand. The effects of exchange rate on the demand for money are investigated in certain periods for Turkey and the tests are conducted to contribute to the studies on the demand for money. The effects of the nominal exchange rate on the money demand function in the Turkish economy between December 2011 and December 2023 have been investigated. In the money demand function, M2 money supply, industrial production index with base year 2015, interest rates on Turkish Lira deposits with maturities up to 1 month and the US dollar nominal buying rate are used. The long-run structural vector autoregression model proposed by Blanchard and Quah (1988) is used in the empirical analysis. As a result of the empirical analysis, the income elasticity of money demand is statistically insignificant. An increase in interest rates as the opportunity cost of holding money decreases the demand for money, which is in line with Keynesian economic theory. It is found that the nominal exchange rate has a negative effect on money demand. Keywords: Money Demand, Exchange Rate, Structural VAR