Abstract

Dynamic modeling is a vital policy instrument in measuring macroeconomic stability of the economy and monetary planning. This study was conducted to explore long term dynamic behavior of the narrow money supply to investigate the nexus between money demand and minimum wages and their impact on macroeconomic stability in Sri Lanka. The empirical approach was directed to estimate a Vector Auto regression (VAR) function through unit root and cointegration, and vector error correction models. The coefficients of the Vector Error Correction Model (VECM) were used to determine the long term elasticity of the dynamic model, and impulse response function was derived to examine the stability of the macroeconomic equilibrium. The multiplier effect depicted that though 72 percent of the long-run effect can be found, minimum wage on money demand, time adjustment of wage is sluggish compared to money demand changes. The impulse response behavior of the minimum wage underscored the macroeconomic stability of the wage-money demand adoption in Sri Lanka. Finally, monetary policy implications were recommended for the relevant entities to adjust minimum wage with the money demand to preserve the narrow money supply.

Key words: Dynamic modeling, money demand, minimum wage, impulse response function.