Investigating Nonlinear Dynamics and Sudden Changes in the Parameters of the Money Demand Function in Iran

The role of money in the design and implementation of monetary policies for price stability, especially since 2007-2009 global financial crisis, has been reintroduced as a major policy issue in both developed and developing countries. In this regard, the money demand function is one of the most important components of any monetary system, which plays a decisive role in the mechanism of transfer of monetary policy to the real sector of the economy. Therefore, in order to analyze monetary issues and to provide appropriate solutions for overcoming economic problems, it is necessary for the policymaker to have a correct understanding of the money demand function. This paper answers the question of whether sudden changes in money supply cause instability in money demand function. Hence, the present study, with Markov switching approach and using simple sum and Divisia, estimates the demand for money function in the Iranian economy during 1988q2 -2020q2 and evaluates its stability. The results indicate that demand for money function is stable in regime one but being in regime two and three, namely the average growth of money and the sharp growth of money, has led to instability in the demand for money function, and the diversion of the monetary policy objectives.