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An Empirical Appraisal of McKinnon’s Complementarity Hypothesis in Tanzania

A.A.L. Kilindo

African Journal of Economic Review, 2020, vol. 08, issue 3

Abstract: The prediction of McKinnon’s Complementarity Hypothesis (McKinnon 1973) is that money and investment are complimentary due to self-financed investment and that the real interest rate is the key determinant of capital formation for financially repressed developing economies. Tanzania has experienced a long spell of financial repression as manifested in government putting caps or ceilings on interest rates, state ownership or control of domestic banks and financial institutions, heavy bank borrowing by government, restrictions on entry to the financial industry and directing credit to certain sectors and public entities. Although financial repression can facilitate economic development, for the case of most developing countries it is hypothesized by McKinnon (1973) and Shaw (1973) that it retards savings and investment and thereby inhibits capital formation and economic growth. This paper critically appraises the complementarity hypothesis in Tanzania by an empirical approach. The Autoregressive Distributed Lag (ARDL) model estimation results and the Bounds Test are supportive of the hypothesis, confirming basic complementarity between accumulation of money balances and investment. Higher real interest rates raise capital formation via the increase in real money balances. The policy implication is an exit from financial repression by achieving positive market determined interest rates in order to secure greater levels of investment.

Keywords: Agribusiness (search for similar items in EconPapers)
Date: 2020
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DOI: 10.22004/ag.econ.308774

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