Estimating the Money Demand Function and a Demystification of the Endogeneity-Exogeneity Nexus of Money Supply: The Case of Zimbabwe (1991-2008)

The main aims of this paper is to fill the gap in monetary economics literature of whether money demand function is static or time-variant overtime and whether money supply is exogenous or endogenous during hyperinflationary episodes in less developed countries setting. It employs both static and dynamic models and a Granger Causality procedure respectively on quarterly data to achieve the two aims. The static model results indicated that money demand, to a larger extend is positively influenced by the rate of inflation and negatively determined by financial innovation, exchange rate and national income and a dynamic model revealed that financial innovation, lagged money demand and national income have negative and, again inflation has a greater positive effect on money demand. Interest rates and exchange rate and, only interest rates were not significant determinants of money demand in the dynamic and static models respectively. The dynamic model gave superior results to the ones from the static one. In both models money demand was found to have an inelastic response to all explanatory variables included. On the other hand, the Granger Causality result found that the money supply endogenously responded to inflation, lagged money stock and the level of financial innovation in the economy but exogenously determined by national income level and the rate of interest rates. The overall conclusion derived from the endogenous-exogenous nexus was that money supply for Zimbabwe over the period 1991 to 2008, when the hyperinflation reached its climax, was endogenous and time variant which explains why it was very difficult for the authorities to tame the hyperinflation bubble. The researcher recommended that, to guarantee the efficiency and potency of monetary policy it is critical for the central bank to be independent from central government and governments also must desist from financing their budget deficits and expenditure through printing notes and minting coins (i.e., seigniorage). Furthermore, endogenous money supply poses more harm to the welfare of citizen of a country when compared to an exogenous one. Therefore, monetary authorities must try by all means to stick to their mandates and not involved in quasi-fiscal operations. In addition, to have policy credibility, there must be clear policy coordination between monetary and fiscal policies and these policies must be consistent. Policy credibility and consistency, in macroeconomic theory, are the cornerstone requirements and pre-requisites to boost most stakeholders’ confidence within the economy.