The Effect of Stock Prices on Demand for Money: The Case of Kenya

Abstract

This study sought to investigate empirically the effect of stock market prices on the long-run demand for real money balances in Kenya. Modern time series econometric methods of co-integration and error correction modelling (ECM) were used to fit
quarterly time series data for the period 1996:I–2011:II. The analysis established the existence of a positive effect of stock market prices on the demand for real money balances in Kenya during the sample period. Among others, the findings suggested the
wealth effect from stock prices dominated the substitution effect in demand for money in Kenya during the sample period. The arising monetary policy implication is one: control for the wealth effect from stock market was important for stable money demand function that would make monetary policy effective in Kenya. Nevertheless, more research is required, including also on the effect of money supply on stock prices.