LINEAR AND NON-LINEAR TECHNIQUES FOR ESTIMATING THE MONEY DEMAND FUNCTION: THE CASE OF SAUDI ARABIA

Abstract

This research is intended to apply linear and non-linear techniques to estimate the money demand function of Saudi Arabia under two alternative approaches using two different measures of monetary aggregates (Divisia and Simple-Sum monetary aggregates). The first approach is the conventional way, which is based on empirical literature where non-oil GDP is used as a measure for income. The second approach is the consumer demand approach to money demand. This approach emphasizes the use of variables that are compatible with consumer demand theory, which emphasizes microeconomic and aggregation theory and deals with monetary assets as durable goods which are directly entered as arguments in the household utility function. The thesis first briefly introduces the topic to in which a concise overview of the recent behavior of Saudi Arabia economy and monetary policy is discussed. Moreover to know the core objective of this research the purpose of the study is mentioned. A hypothesis question is developed as an addition to the purpose of the study. Furthermore, in the first chapter, the economy of Saudi Arabia and recent developments are discussed in details after which the financial system is discussed as it is necessary to get basic knowledge of how the financial system of the country first someone is to find out the money demand behavior of a certain country, and it may also be essential the practices of the relevant commerce institutions that how they are engaged in conducting of the monetary policy, thus for this essential requirement the conduct of the monetary policy in Saudi Arabia is discussed after the discussion on the financial system of Saudi Arabia. After this, in the second chapter, the Divisia monetary aggregate technique is discussed in detail. This chapter presents the process of constructing Divisia Monetary Aggregates for Saudi Arabia and compares Simple-sum and Divisia Monetary Aggregates for Saudi Arabia. The third chapter deals with the literature on the theoretical aspects of demand for money in general with different approaches to the demand for money explained vividly. Part of this chapter discusses the salient aspects of money demand in the context of Saudi Arabia. And in the fourth chapter, any hypothesized assumption, suggestion and recommendations are discussed followed by the methodology exploited in the research of this topic. It is also ensured that the methods used in data collection and the research of this thesis are not merged with the methods which are actually used to create links between the linear and non-linear techniques which are used to predict the money demand in Saudi Arabia. And in the last, in chapter five, the analysis of experimental data is discussed so that detailed statistical information could be presented to support the theory discussed in other parts of the research. The analyses and examinations of the long-run and the short-run of the money demand functions for all alternative measures of monetary aggregates show that Divisia aggregates, when compared to their Simple-Sum counterparts, can serve as a potential target in formulating monetary policy in Saudi Arabia. This is explained by the fact that the Divisia aggregates provide a framework for dealing with the effects of financial innovations and also perform better at a high level of aggregation. Since Saudi Arabia is pursuing a policy of financial deregulation, which certainly will raise the competition and financial innovation in the financial industry, the use of Divisia monetary aggregates as policy instruments is suggested.