On Black Market Exchange Rate and Demand For Money in Developing Countries: The Case of Nigeria M. KABIR HASSAN, K. CHOUDHURY, AND M. WAHEEDUZZAMAN* This paper examines the hitherto unexplored question of the effects of the black market exchange rate expectations on the domestic demand for money in Nigeria. This study finds that real income and expected inflation rates are the appropriate scale and opportunity cost variables for the demand for money function in Nigeria. The results also suggest that depreciation in black market exchange rate exerts a significant negative impact on the domestic demand for money. A policy implication of this research is that since a depreciation of the black market exchange rate tends to decrease the demand for money, it should be taken into account in the execution of monetary policy. (JEL E41) I. Introduction The purpose of this paper is to examine empirically the impact of the black market exchange rate on the demand for money in Nigeria. The bulk of the empirical money demand research has been conducted on developed countries. By now, it has been generally accepted that for developed countries, permanent income is an appropriate scale variable, while for developing countries such an argument still remains inconclusive. Both permanent and measured income have been found to be close substitutes in developing countries [Adekunle, 1968; Laumas and Laumas, 1976; Fry, 1978]. Similarly, in the literature, it has also been accepted that in developed countries, the nominal interest rate is a suitable opportunity cost variable of holding money. By contrast, the expected rate of inflation has been accepted as the true opportunity cost of holding money for developing countries. Because money markets are relatively thin and controlled in developing countries, the interest rate does not represent the true opportunity cost of holding money. In most developing countries, the choices of asset holders are limited to or between mostly money and goods, and not between money and financial assets. Owing to the lack of alternative financial assets, the individuals in these economies are generally constrained to invest in bank deposits and bank bonds, the interest rates on which are set by the countries' monetary authorities. Changes in these administered rates are made very infrequently, and therefore these rates show little or no variations over time [Wong, 1977; Hassan, 1992]. The authors would like to thank an anonymousreferee for helpful suggestions which substantially improvedthe qualityof the paper. This researchwas supported in part by a summerresearchgrant fromthe College of Business Administration,Universityof New Orleans. 35