The objectives of my project were to estimate a model of money demand in Albania and to assess whether the large increase in real balances during the 2008 global crisis represents a structural break. The study is conducted within a portfolio approach framework in which money holdings are seen as a choice between alternative assets, including real and financial, and domestic and foreign assets. In this regard, the yield of foreign financial instruments, expressed in local currency, has been presented as a key determinant of money demand.
The successful inclusion of a foreign financial yield variable, which combines the effect of both foreign interest rates and the expected rate of depreciation of the lek, suggests that there is or has been substitutability between domestic currency (or domestic financial instruments) and foreign deposits or financial instruments. In this connection, the M2 equation suggests that movements in broad money after the country was hit by the global crisis could be explained by economic performance and interest rate differential, expressed in Albanian leks. While narrow money seems to be influenced, apart from economic activity, by the opportunity costs solely in domestic currency. Indeed, in all of the stability tests conducted for mid-2008 to end-2014, the hypothesis of a structural break is consistently rejected.
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