The policies depend on the capacity to adjust money provide to its demand in order to prevent monetary disturbances from affecting real output. Due to the vital role of money demand in macroeconomic analysis, i.e. formation and transmission of monetary policy. The past several decades have witnessed considerable empirical research on this factor in developed and developing countries. Limited studies have assessed the impact of government expenditures and inflation on the demand for money in Pakistan. In the present study, the main focus is to determine the long and short-run relationship between government expenditures, inflation, and demand for money in Pakistan. To measure this relationship, time series data have been taken over the period 1980-2018 from World Development Indicators (WDI, 2019). The ADF test is used to check the stationarity of data and found that all variables are I(1). The Trace value and Eigenvalue statistics show that there exist two Eigenvectors. The empirical results show that government expenditures, inflation, household final consumption expenditures, foreign direct investment, and export have a positive and significant relationship with demand for money. Error Correction Model (ECM) is used to measure the short-run effect. The empirical results show that there is no issue of heteroscedasticity (Godfrey, Glejser, ARCH, and White), normality (Jarque-Bera), serial correlation (Breush-Godfrey), and model specification (Ramsey RESET) among the residuals. The CUSUM and CUSUMQ plots are used to check the stability of parameters of the model, and plots by using our empirical data show that the parameters are stable.
Key words: Demand for money, Inflation, Government expenditure, Disaggregate approach, Co-integration, Pakistan
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