THE IMPACT OF GOVERNMENT DOMESTIC VERSUS EXTERNAL DEBT ON MONEY DEMAND: EMPIRICAL EVIDENCE FROM PAKISTAN

Abstract

This study attempts to analyze the relationship between government debt and money demand in the context of Pakistan by taking the annual data over the period of 1976 to 2012. In this regard, effects of government domestic alongside external debt are examined separately under the framework of Autoregressive Distributed Lag Approach of cointegration. The findings of Bound test analysis and negative sing of ECM (-1) term, both indicate that positive significant relationship exists between domestic debt and demand of real money balances  in the long run as well as in short run. It suggests that government internal debt is the source of net wealth and bondholders feel them wealthier by considering the interest income as an increase in their private wealth. On the other hand, the empirical result revealed that no cointegration relationship exists between external debt and money demand, which implies that external debt does not view as a source of net wealth and government of Pakistan remains ineffective to transfer the proceeds from public external debt to the domestic individuals who are willing to invest or consume. So, in our findings, only domestic debt is appeared as a missing variable in the money demand function.