Since 1991, the Egyptian authorities have implemented a variety of economic reforms and
structural adjustment programs in order to liberalize the country’s financial sector. The aim
of those reforms was to eliminate the internal and external imbalances caused by years of
high inflation rates, unsustainable fiscal deficits, a lack of competitiveness in global markets,
and intolerable levels of external indebtedness. This move towards the use of greater marketbased
signals as a means to manage the economy poses a number of challenges for the
effective implementation of monetary policy. In particular, the liberalization and unification
of the exchange rate regime, the ongoing commitment to the implementation of an inflationtargeting
framework, and the continued liberalization of interest rates have substantially
affected the environment in which monetary policy operates.1 These changes may have a
large impact on the demand for broad money, because they could raise the opportunity cost
of holding money, or provide some alternative assets to holding money. Furthermore, the
existence of alternative assets might allow individuals to substitute between domestic and
foreign currencies, as well as between monetary and physical assets.
A common objective in almost every study that analyzes the demand for money is to test
for the stability of the demand for money, no matter which monetary aggregate is used.2 The
existence of a stable money demand function forms the basis for formulating and implementing
monetary policy.3 If the demand for money function is found to be unstable, then practitioners
focus on the problem of omitted variables by showing that once these omitted variables are
included, the stability of the money demand function can be attained.4 For instance, in
testing for the stability of the demand for money function in the US, McNown and Wallace
(1992) show that a practitioner must include the nominal effective exchange rate to take into
account the possibility of currency substitution between the US and the rest of the world.
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