Financial liberalization and demand for money nexus in Ghana

Abstract

This study examines the relationship between financial liberalization and demand for money in Ghana using time series data from 1984 to 2020. The study used the autoregressive distributed lags (ARDL) model to estimate the short- and long-run relationship between money demand and financial liberalization, as well as other determinants of money demand. The Augmented Dickey-Fuller (ADF) and Phillips- Perron (PP) tests showed stationarity of all variables after first-differencing, whereas inflation was stationary at levels. The cointegration test revealed a long-run cointegrating relationship and hence an estimation of the unrestricted error correction model (UECM). The results revealed that the estimates were significant and yielded the expected signs consistent with theory, except for inflation but it was nonetheless statistically insignificant. Financial liberalization was found to have a significant positive relationship with money demand in both short and long run periods. The error correction term was found to be significant and it yielded the expected negative sign showing that 12 percent of the disequilibrium from previous annual periods converges back to long-run equilibrium in the current period. The Granger Causality test established no causal relationship between the demand for money and financial liberalization. In the end, the CUSUM, CUSUMSQ, and MOSUM plots diagnosed a stable demand for money function in Ghana. The threshold model estimated in the study revealed that financial liberalization had a positive effect on the demand for money in the initial stages until it reaches a threshold level of 29.34% where further liberalization of the financial sector affects the money demand function in Ghana negatively, and so the study recommends that the Bank of Ghana should be cautious about the degree of financial liberalization they pursue to achieve optimal money demand. If the degree of financial liberalization is below the threshold level, increasing it could stimulate money demand, but conversely, if it above the threshold level, reducing it could stabilize money demand. Since exchange rate had a significant negative relationship with money demand, the study recommends that the Bank of Ghana uses exchange rate as an intermediate target to achieve price stability in periods of inflation and recession. Again, the study recommends that since financial liberalization has a significant positive relationship with money demand, the Bank of Ghana adopts policies that ensure rigorous financial discipline to prevent future bank crises.