Nonlinear ARDL Approach and the Demand for Money in Iran

To account for currency substitution, most studies today include exchange rate as a determinant of the demand for money, in addition to income and interest rate. This tradition goes back to Robert Mundell who introduced this notion in 1963. In this paper, we demonstrate that the failure to find a significant relationship between exchange rate and the demand for money could be due to assuming a linear adjustment mechanism among the variables. Once we introduce nonlinearity in the short run as well as in the long run through partial sum concept, we show that currency appreciation or depreciation could affect the demand for money in an asymmetric manner. This is demonstrated using data from Iran.