A Comparative Analysis of Narrow and Broad Money Demand in India: New Evidence from the ARDL Bounds Testing Approach
Abstract
This paper evaluates the macroeconomic and financial determinants of the money demand of India from 1996: Q1 to 2024: Q4. The paper utilizes the Autoregressive Distributed Lags (ARDL) bounds testing framework and an Error Correction Model (ECM) to estimate the long-run equilibrium and the short-run dynamics of monetary aggregates, narrow money (M1) and broad money (M3). The empirical findings confirm a stable, singularly cointegrated relationship between real money balances (M1, M3), real income (GDP), opportunity cost (91-Day Treasury Bill Rate), and equity wealth (BSE Sensex). Since M1’s income elasticity is 0.53 and M3’s is 0.98, the traditional transaction motives dominate both M1 and M3. The interest rate exerts a negative substitution effect on M1; however, M3 remains structurally safeguarded against short-term fluctuations. Equity market valuations exhibit statistical insignificance across all variable specifications, indicating that the equity market fluctuations do not systematically destabilize long-run money demand. The ECM results reveal a short-term adjustment speed of 17.92% and 8.37% per quarter for M1 and M3, respectively. These findings establish that M3 acts as a robust and stable measure of the Reserve Bank of India’s long-term monetary targeting, driven predominantly by the fluctuations in real fundamental macro variables.