This paper examines the role of financial liberalization on money demand in Sri
Lanka covering the duration over 1963 to 2008. Taking the structural break into
consideration, it is detected that financial liberalization does not have such a strong
positive association with money demand as suggested by McKinnon-Shaw hypothesis;
rather it is negative in both long-run and short-run. However, we found strong evidence
that the exchange rate and interest rate reform initiated in 1977 has a substantial
contribution to expand both narrow and broad money demand.