FINANCIAL INTEGRATION, EXCHANGE RATE VOLATILITY, INFLATION AND MONEY DEMAND IN G7 COUNTRIES

Abstract This study investigates the threshold effects of financial integration, exchange rate volatility, and inflation on money demand in G7 countries over the period 2000 to 2024, employing a nonlinear Panel Vector Error Correction Model (PVECM). The model captures both short-run dynamics and long-run equilibrium relationships, while accounting for regime-dependent behavior across key macroeconomic variables. The findings reveal that money demand in advanced economies does not respond uniformly to changes in financial or macroeconomic conditions. Specifically, exchange rate volatility and inflation exhibit nonlinear effects: under low-volatility and low-inflation regimes, both variables reduce money demand; however, beyond certain threshold levels, their impact reverses leading to increased demand for money due to precautionary and transactional motives. Financial integration consistently exerts a positive influence on money demand, with significantly greater effects observed once a country surpasses a critical level of financial openness. These results underscore the importance of flexible and responsive monetary policy frameworks that recognize the nonlinear and state-contingent nature of macroeconomic relationships. Policymakers in G7 economies must anticipate behavioral shifts in money demand as economies transition between regimes, especially in response to rising integration, inflationary pressures, or external shocks. The study contributes to the empirical literature by uncovering structural thresholds in money demand functions and providing evidence for dynamic, regime-sensitive monetary management in globally interconnected economies.