Domestic Interest Rates Have Inverse Relationship With Currency Demand In Long Run

Domestic interest rates have an inverse relationship with currency demand in the long run, i.e., higher the interest rates in the system, lower is the demand for currency and vice versa, noted a latest research paper from the Reserve Bank Of India. The paper written by Janak Raj, Indranil Bhattacharyya, Samir Ranjan Behera, Joice John and Bhimappa Arjun Talwar uses several time series and econometric techniques to forecast and analyse currency demand in India for: (a) forecasting currency in circulation at a weekly frequency based on institutional and idiosyncratic factors; and (b) analysing the macroeconomic factors and technological innovations which impact movements in currency demand over monthly, quarterly and annual intervals.

The key findings emerging from the study are: (i) demonetisation has resulted in a permanent downward shift in the trajectory of currency demand, i.e., in the absence of demonetisation, currency demand would have been higher than what it is; (ii) currency demand shows strong seasonality during festive seasons, especially Diwali; (iii) currency demand also increases during elections; (iv) an increase in the number of credit/debit card transactions dampens currency demand; (v) currency demand has unitary income elasticity, i.e., it expands broadly in line with the growth in nominal GDP; and (vi) interest rates have an inverse relationship with currency demand in the long run, i.e., higher the interest rates in the system, lower is the demand for currency and vice versa.

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