Tiến Sĩ Demand for money in lao pdr and policy implications

Luận án tiến sĩ bằng tiếng Anh năm 2012
Đề tài: DEMAND FOR MONEY IN LAO PDR AND POLICY IMPLICATIONS

TABLE OF CONTENTS
DECLARATION i
ACKNOWLEDGEMENT ii
TABLE OF CONTENTS . iv
ABBREVIATION vi
LIST OF TABLES vii
LIST OF FIGURES . viii
INTRODUCTION . 1
CHAPTER I: OVERVIEW OF THEORETICAL AND EMPIRICAL
STUDIES ON MONEY DEMAND 7
1.1. A brief theoretical overview 7
1.1.1. Quantity theory of demand for money . 7
1.1.2. Keynesian approach (John Maynard Keynes) 10
1.1.3. Friedman‟s model of the demand for money . 14
1.2. Some empirical problems in estimating money demand functions . 15
1.2.1. Functional forms . 16
1.2.2. Choice of variables . 17
1.2.3. Empirical estimation problems . 20
1.3. Some Asia-specific studies on the money demand function . 23
Conclusion of chapter 1 28
CHAPTER II: LAO FINANCIAL SYSTEM AND MONETARY POLICY 31
2.1. Economic development 31
2.2. Overview of monetary developments in Lao PDR 34
2.3. Banking system . 35
2.3.1. Mono-bank system. 37
2.3.2. Banking system reform 40
2.4. Monetary Policy 47
2.4.1. Monetary instruments. 47
2.4.2. Target of monetary policy 51
2.5. Dollarization 54
2.6 Bond market 56
2.7 Stock market . 58
2.8 Interbank market . 59
2.9 Exchange rate policy 60
Conclusion of chapter 2 66
CHAPTER III: DEMAND FOR MONEY IN LAO PDR . 67
3.1. The theory-based money demand function for Lao PDR . 67
3.2. Data description and issues . 69
3.2.1. Definition of money . 69
3.2.2. Scale variable 71
3.2.3. Opportunity costs 71
3.3. Unit root and co-integrated test 73
3.3.1. Unit roots test . 73
3.3.2. Johansen co-integration test . 74
3.4. Estimating money demand function for Lao PDR by using ECM 76
3.4.1. Engle and Granger: Error Correction Models 76
3.4.2. Estimated results and hypothesis testing 77
Conclusion of chapter 3 93
CHAPTER IV: POLICY IMPLICATIONS . 94
4.1. Laos economic development strategy . 94
4.1.1. Macro-economic targets . 94
4.1.2. Targets of Economic Sectors 95
4.2. Monetary policy recommendations 99
4.2.1. Monetary instruments . 100
4.2.2. Choosing intermediate target 100
4.2.3. Increasing banking supervisor 102
4.3. Some recommendations to Lao government 103
4.3.1. Dedollarization . 103
4.3.2. Stimulate financial market development 105
CONCLUSION 107
REFERENCE 109
APPENDIX 115

INTRODUCTION
The international experiences confirm that countries with well-developed
financial systems grow faster and more consisten tly and are better able to
adjust to economic shocks. A good financial market and system of institutions
can channel funds from savers to the most productive investors. A typical
financial system in a transitional economy, especially banking system had
limited capacity to assess credit risk and fund allocation accordin g to the
government plans. Furthermore, government had a strong control over the
financial system, such as setting interest rate ceilings, entry barriers, and
interference in credit allocation. According to McKinnon (1973) and Shaw
(1973), such financial repression leads to reduction in private savings, thereby
decreasing the resources available to finance capital accumulation, with a
negative impact on growth.
The Lao PDR is in the process of transition toward a market economy,
the requirement of government‟s operation to change its intervention methods
and scope is a fundamental way. One of these fundamental changes is the way
the government conducts its monetary policy as well as the development of
financial system, especially the banking system to achieve desirable economic
growth. The relationship between monetary growth and economic growth is
still on debate. Hossain and Chowdhuey (1996 p.126) argued that there is a
clear correlation between money supply growth and economic growth in the
long-run. Other studies in the field also point out the importance of monetary
policy, especially, in managing the demand side of the economy.
In order to make the monetary policy more efficient and effective, the
prerequisite for the monetary authority must be able to predict the demand for
money of the economy with acceptable accuracy. Theoretical views of
demand for money have usually been based on the consideration of money as
a medium of exchange. The Keynesian models represent money with the role
of transactions and the role of store of value. Analytically, demand for money
is the sum of three components: transactions, precautionary, and speculative
demand. Milton Friedman argued that physical goods should be regarded as a
substitute for money and that higher expected rate of inflation should induce a
portfolio shift from money to physical assets as well as financial assets (hard
currencies) in the context of transition and underdeveloped countries. The fact
that money does not bring interests like other alternative assets means that
money holders should receive compensation in some other forms. Following
the idea of Keynes, many economists attempted to model the demand for
money based on the above consideration. Although they are different
technically, the main idea is still based on the so -called „liquidity services‟,
which money gives in compensation for the interest earning foregone.
The relationship between the demand for money and its key
determinants is an important building block in macroeconomic theories and is
a crucial component in the conduct of monetary policy (Goldfeld, 1974).
Even in the era of inflation targeting, a well-specified money demand function
is of utmost importance for the effective implementation of monetary policy –
especially to track both, the interest rates and the stock of money – in order to
access the impact of monetary policy upon the economy. As a result, the issue
of long-run relationship between broad money, its determinants and also the
stability of the demand for money has always been in the center of research.
Stable money demand is particularly important for policy makers to
choose a credible monetary policy instrument. For instance, the unstable
money demand caused by the financial reforms of the late 1970s, the financial
innovations and the financial integration induced many central banks in
developed countries to switch from monetary targeting to the interest rate
targeting as a monetary policy instrument. The same view was proposed by
Poole (1970) who showed that the interest rate should be targeted if the
money demand function is unstable. However, monetary targeting can play an
important role in the formulation of an efficient monetary policy strategy,
even though the monetary policy of developed countries typically uses an
interest rate targeting as a policy instrument. Monetary aggregates can be
appropriate indicators for future inflation in the medium term and long -term.
As mentioned by Valadkhani (2006) an emerging consensus among
economists is that it is not advisable to concentrate exclusively on a single
policy instrument while neglecting another important information variable.
Both interest rate and monetary aggregates are important in selecting
appropriate monetary policy actions. Monetary aggregates, however, will only
be related to the real economy if the money demand function is stable. Thus,
the stability of money demand entails whether monetary targeting is an
appropriate guide to policy.
Due to its particular importance, the money demand function was studied
extensively in many countries as can be seen from a large body of literature
on theoretical as well as empirical studies of the demand for money, which
discussed in Chapter I. However, these studies had been largely carried out
for developed countries. One explanation for that is the lack of good quality
data on developing countries. Lao PDR is not an exception in that respect.
Indeed, the low quality and short time horizon of Lao economic data is well
known among researchers. One main reason is that Lao PDR just adopted the
system of national account (SNA) in 1992 and the statistical system is still
underdeveloped.
The dissertation titled “Demand for money in Lao PDR and policy
implications” can be viewed as earliest resea rch in the case of Lao PDR. This
fact, while telling us about many difficulties, also can be viewed as an
encouraging attempt for us since „learning by doing‟ in many cases may be
the best strategy to learn.
Objectives of research
The main purpose of this dissertation is to estimate the money demand
function for Lao PDR during the period of the first quarter of 1993 to the
second quarter of 2010 (1993Q1-2010Q2), using available data. Taking into
account some limitations mentioned above, conclusion of the dissertation
should be viewed as a suggestion. However, by doing so it is hopefully to
establish an appropriate framework for future studies in this field once the
comprehensive data are available. In addition, the results of this study can
hopefully reveal some important issues and areas required to improve,
especially data problems which will raise awareness among policy makers to
improve the quality of economic database of the country.
Research Questions
The main research question: What is the money for demand in the Lao PDR?
The specific research questions:
1. What are the behavior of money demand patterns?
2. How has the money demand contributed to the monetary stability for
the conduct of monetary policy?
3. What are direct and indirect factors influencing the demand for money
in the Lao PDR?
4. What are the problems and obstacles confronting the Lao PDR in
conducting monetary policy?
Research Methodology
In light of analyzing money demand function for Laos, this study uses a
basic and popular theoretical framework surrounding the money demand
analyzed from various empirical works. After formulating the theoretical
model, this dissertation adopts a framework of the Error Correction Model,
which is widely used, to analyse the money demand in both developed and
developing economies, to examine factors driving money demand balances in
Lao PDR over a period of 1993-2011. This econometric model, an Error
Correction Model is believed to be well- suited for the empirical investigation
through rigorous empirical testing.
Contribution of the study
To the best knowledge of the author, the current study represents the first
attempt to examine the factors influencing the money demand for Lao PDR.
This study will provide a quantifiable estimation of the money demand in Lao
PDR for the first time by using a quarterly data. The outcomes of the study can
be useful for the purpose of conducting monetary policy for policy makers of the
country‟s central bank. The economic variables which are used to conduct
monetary policy identified in this study will be helpful to systematically consider
for monetary policy and facilitate policy discussions in the country. The outcomes
will provide the information needed in key decisions and in formulating the future
design of monetary and exchange rate policies, which will significantly impact on
the overall macroeconomic stability. The findings will be useful for central
bankers to understand the factors influencing money demand in the Lao PDR,
especially taking into account of dollarization problem prevailing in the economy.
The study also updates the database of the Lao PDR financial statistics. One
important contribution of this study is constructing economic variables especially
annual GDP data to quarterly GDP data. This provides a good starting point to
study the relationships between the money balance and other economic variables
in the economic framework. Further, this study can be adopted to estimate money
demand in other similar developing countries as the Lao PDR.
Database
The data used in this analysis is taken from the Bank of Lao PDR. The
estimated sample uses quarterly data in the period from Q1/1993 to Q2/2010.
Structure of dissertation
Besides the introduction, conclusion, appendices, references, this
dissertation includes 4 chapters as follows:
Chapter I: Overview of theoretical and empirical studies on money demand
This chapter reviews the main theories of money demand in order to
explore what factors can affect the demand for money. It also present some
empirical studies of money demand. The lessons learned from literature
survey will help select the appropriate modeling framework and choosing
suitable variables in the following chapters.
Chapter II: Lao PDR financial system and monetary policy.
The overview of financial system development of Lao PDR will be
presented in this chapter. In particular, major developments of the banking
sector in the last 20 years will be reviewed. The monetary policy will be
sketched with emphasis on the new role of the Bank of the Lao PDR. The
current pros and corns of BOL monetary policy raises the need to estimate
money demand function.
Chapter III: Demand for money in Lao P.D.R.
In this chapter, the empirical framework of money demand function for
Lao PDR. will be formulated and estimated; the specific problems in the case
of Lao PDR. will also be discussed.
Chapter IV: Policy implications.
Based on empirical estimation of chapter III, some policy implications
for not only the Lao government but also for the BOL will be suggested in
this chapter.

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