Exchange rate sensitivity of the demand for money in developing countries

There is consensus among researches that under the present floating exchange rate system although developing countries peg their exchange rate to a major currency, they cannot avoid fluctuation in their effective exchange rates as long as major currencies fluctuate against one another. Few authors have investigated the effects of changes in effective exchange rates of developing countries on their imports, exports, trade balance, demand for international reserves, inflation etc. In this paper we try to inestigate the effects of effective exchange rates of developing countries on their demand for money. Previous authors who have estimated a money demand function, inclusive of an exchange rate variable (bilateral or effective), have restricted themselves to industrial countries only. By using quarterly data over the 1973–85 period, it is shown that in most developing countries, while the short-run effcts of depreciation could be in either direction, its long-run effects are negative indicating that depreciation causes a decline in the demand for domestic currency.