LA02.022_Demand for money in Lao PDR and policy implications
SUMMARY OF FINDINGS OF THE Ph.D DISSERTATION
Topic of dissertation: Demand for money in Lao PDR and policy implications
Specialization: Finance and Banking
PhD candidate: Somphao Phaysith
Supervisor : Prof. Dr. Tran Tho Dat
The followings are considered to be the findings of the PhD dissertation:
Demand for money plays a major role in macroeconomic analysis, especially in selecting appropriate monetary policy actions. In order to control the banking system efficiently, the Bank of the Lao PDR (BOL) should consider the demand side when conducting monetary policy. Up to now, there is no empirical study about money demand for the Lao economy. Thus, this is the first study about demand for money for the Lao PDR. This disertation aims to explore the dynamic relationship between money balance and four other macroeconomic variables: real GDP, expected inflation, exchange rates, and domestic and foreign interest rates by modeling and testing for stability of money demand functions in the Lao PDR during the period of 1993:Q1-2010:Q2.
1. OVERVIEW OF LAOS BANKING AND FINANCIAL DEVELOPMENT
The Lao PDR is in the process of a transition towards a market economy. The Lao economy has experienced high fluctuations of inflation rates. Monetary growth rates have not been calculated by considering the demand side. The monetary policy framework is limited and incomplete. The exchange rate mechanism is not yet fully consistent with the actual conditions, thereby limiting the efficiency of its implementation. The main tools of BOL are interest rates, reserve requirements, and discount window lending. The BOL has only used open market operations since the Laos stock market has been opened for more than one year. The financial market is developing within a limited scope. The Lao economy is also partially dollarized.
2. DEMAND FOR MONEY IN THE LAO PDR
Demand for narrow money, broad money in Kip and board money in foreign currencies were estimated. The estimated results suggested that all demand functions are stable. Coefficient signs are suitable with theory. The study results indicate: (i) there is evidence of ample influence of the exchange rate and interest rates on money balance dynamics in the Lao PDR and this outcome is associated with a high degree of multi-currency use in the Lao PDR; (ii) expected inflation shows the effect of high inflation episodes on money balances, especially in terms of foreign currency, even though the country has improved its macroeconomic stability over recent years; and (iii) the local currency is used mostly for transaction purposes compared to that of foreign currencies .
3. POLICY IMPLICATIONS
The study of money demand for the Lao PRD gives some suggestions for BOL and the Lao government in controlling the economy and conducting monetary policy. BOL can use narrow money, broad money in Kip and board money in foreign currencies as intermediate targets of monetary policy. BOL should take into account the effects of currency substitution and the capital mobility of the Lao PDR in a multi-currency economy. BOL should use open market operations frequently in controlling the money supply since it is the most effective tool in conducting monetary policy in the world. BOL also needs to strengthen banking supervision to make the banking sector operate more efficiently. The Lao government should stimulate the development of the financial system and by step by step de-dollarizing.
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