The Impact of Government Deficits on Money Demand: Evidence from Saudi Arabia

Abstract

This study examines the effect of budget deficit on money demand in Saudi Arabia. The Cointegration test indicates the existence of a long run equilibrium between money demand and its determinants; namely, gross domestic product, government expenditure, interest rate, inflation rate, and budget deficits. The Error Correction Model shows that 40% of the disequilibrium in money demand is corrected each year. The coefficient of the budget deficit is statistically significant but negative in both long and short runs. This result does support neither the Keynesian-Neoclassical point view nor the Ricardian hypothesis. This result may be attributed to two reasons: first the ratio of budget deficit to GDP is very small. Therefore, the results may differ if the ratio of budget deficit to GDP increases over time. Second, government bonds are not part of the household's wealth since government are held only by commercial banks, However, the results may change if government allows the public to hold government's bonds.