Determinants of money demand in Uganda

Abstract

The global financial and economic crisis has brought new challenges for monetary authorities in the attempt of enhancing financial stability. The study sought to explain the determinants of money demand in the Republic of Uganda. The study uses the Ordinary Least Squares methodology to establish the existence of a long-run relationship and the short-run dynamics that are modelled via the error correction model. The study establishes that broad money is positively related to real GDP, nominal exchange rate and interest rate spread, however it is negatively related to inflation. The income elasticity of the demand for money revolves around unity and is positive and significant in explaining the demand for real money both in the short and long run. The short-run model justifies the existence of co integrating relationships. 39 percent of adjustment to an exogenous shock occurs in one quarter. Key to note from the results as a matter of policy concern in both cases i.e. long and short run, the exchange rate elasticity is higher than the interest rate elasticity, suggesting that the exchange rate channel is stronger than the interest rate channel in the monetary policy transmission mechanism. The government is encouraged to increase GDP by lowering the interest rates, ensure increased wages, ensuring high global growth leading to increased export spending and devaluation of the currency to make exports cheaper.