Policy Reforms and Stability of the Money Demand Function in India

The traditional policy regimes need to be re-examined in the wake of the fast-emerging globalised world economy. This is particularly true in the case of developing economies and more so when it comes to monetary policy. This is because of the growing link between domestic money and financial markets on the one hand and the foreign exchange market on the other. A central building block in this context is the money demand function which must be stable and able to provide adequate linkages for policy formulation. This is the focus of this exercise as it attempts to relate the demand for real stock of money to the exchange rate, and to other familiar variables like rate of inflation, interest rate and the level of economic activity. The results are significant from the policy point of view under the new economic policy regime.