Modeling Money Demand under the Profit-Sharing Banking Scheme: Evidence on Policy Invariance and Long-Run Stability

This paper extends the literature on interest-free banking systems by modeling money demand equations for Iran which has followed the profit-sharing scheme since the mid-1980s. Using quarterly data spanning the period 1966-2001, we estimate two alternative demand equations for M 1 and profit-sharing deposits. Unlike prior research, this paper focuses on whether the estimated equations are policy invariant in addition of being temporally stable in the short- and long- run. Our empirical results persistently suggest that the two money demand models, and especially the demand for profit-sharing deposits, are structurally stable and policy invariant despite the numerous shocks that have characterized Iran in recent years. These results provide another piece of evidence supportive of the interest-free banking system, and suggest that profit-sharing monetary aggregates represent a credible instrument for monetary policy-making in Iran.