Household Demand for Money in an Underdeveloped Economy : A Case Study of India

The paper tries to overcome some of the empirical problems that are associated with the estimation of demand-for-money function in an underdeveloped economy. It deals explicitly with the choice of functional form and inclusion of interest rate as an explanatory variable to serve as opportunity cost of holding money in the money demand function using both narrow and broad definitions of money. The paper concludes that short- or long-period interest rates serve as an opportunity cost of holding money in India only when a narrow definition of money is used. Time deposits were found to be sensitive to the maturity structure of financial instruments. As regards the choice of functional form, the paper holds that it makes no difference whether the function is estimated by linear form or by log-linear form. The paper also confirms for India the results of Friedman’s seminal study for the United States.