Abstract:
A stable money demand function and exogeneity of prices is at the core of planning and
implementing a monetary policy of monetary targets. This thesis examines both the stability of
M2 money demand and price exogeneity in Rwanda for the years 1980 to 2000. We estimate
and test the elasticities of the determinants of Rwandan money demand function. We include
in this demand function those variables which economic theory indicates must be part of any
empirical investigation of money demand. All coefficients had the signs as required by
economic theory. We estimate the money demand function for Rwanda using cointegration
analysis and an error correction mechanism. The results show real income, prices and M2 to
be cointegrated. We employ three tests to show that the estimated demand function for
Rwanda is stable. We then test the second requirement for coherence in monetary aggregate
targeting that money determines prices. The results show that prices are exogenous to money.
But before we can definitely conclude that an inflation targeting regime is feasible from
monetary policy perspective, we point out that future research on this important topic must
account for exchange rate movements, measure permanent income and specify interest rate
changes correctly.
