Determinants of demand for money in Tanzania

The main purpose of the study was to ascertain the determinants and the stability of the money demand function in Tanzania. In contrast to most macro-economic studies on money demand functions, the study used a comprehensive data set covering pre-reforms and post reforms periods to attain fresh estimates of the real demand for money function to be employed in carrying out the analysis of monetary policy in Tanzania. The study employed time series data techniques in the estimation of the money demand function. The empirical results were obtained by the use of the error correction model. The results show that all variables including real income, interest rate, real exchange rate and inflation had the hypothesized signs as expected by the theory. The variables were found to be significant and related to money demand in Tanzania. The study has brought to light the sensitivity of the demand for money to openness variables, namely, the exchange rate. Thus the study recommends an intervention policy intended to stabilize the exchange rate in order to curb the substitution of the local currency with the foreign currency. Moreover the study foresees that the implementation of changes related to income will prove effective in changing the level of liquidity in Tanzania. This is due to the underdeveloped nature of the financial systems of the less developed economies (LDC’s) like Tanzania, meaning that income-related factors (scale variables) are more effective in determining the demand for money balances.