The stability of the demand for money function in Islamic and non-Islamic monetary policy regimes

This study, using quarterly data from Egypt and Iran, extends the literature on demand for money by examining the stability of money demand functions in two different monetary policy regimes, an Islamic banking system and a conventional banking system. A stable demand for money enables central banks accurately to predict the demand for money and hence attain a price stability objective through the adjustment of the money supply. This paper adopts a restructured form of Friedman's (1956) model, which considers real demand for money as an extension to the theory of demand for durable goods. The study estimates the long-run demand for money functions in Iran, which represents an Islamic banking system, and Egypt, which represents a conventional banking system. The study then examines empirically the stability of the demand for money function under two different financial systems. The study finds that the demand for money function is stable under the Islamic banking system and unstable under the interest-based banking system. [web URL: http://www.economicissues.org.uk/Vol21.html#a4]