Testing the Validity of Keynesian Liquidity Preference Theory and Velocity of Money Demand Function in Nigeria

The essence of this study is to test the validity of Keynesian Liquidity Preference theory as well as the velocity of money demand in Nigeria using annual time-series data covering between 1970 and 2014. The stationarity of the data was ascertain using both Augmented Dickey-Fuller (ADF) and Phillips-Perron (PP) tests, and the result reveal that apart from interest rate, all the variables are stationary at first difference. Data were analyzed using Ordinary Least Squares (OLS) estimation technique. Cumulative Sum (CUSUM) and Cumulative Sum of Recursive Residuals Squares (CUSUMSQ) were also employed to test the velocity of money demand function. The result shows that interest rate, inflation and official exchange rates significantly influence the demand for money while income has no significant effect. All the variables conform to a priori expectations thereby validating the Keynesian liquidity preference theory in Nigeria. The result from the stability test shows a constant velocity of money demand function in Nigeria. Monetary authorities should therefore adopt appropriate policies that place interest rate, inflation and official exchange rates at an acceptable level to ensure optimal demand for money to spur income through private investments in the real sector.