Interest Rate Deregulation and Private Investment: Revisiting the McKinnon-Shaw Hypothesis in Ghana

Eric Osei-Assibey and William Baah-Boateng

The IUP Journal of Applied Economics, 2012, vol. XI, issue 2, 12-30

Abstract: : The study re-examines the McKinnon-Shaw financial liberalization hypothesis, which posits simply that high real deposit interest rates increase financial savings, which in turn lead to increase in the quantity and quality of domestic investment. More specifically, the study investigates the impact of interest rate deregulation on investment in Ghana and the transmission mechanism through which this could happen. Utilizing cointegration and error correction model techniques with data for the period 1970-2005, the study’s findings are as follows. While the study finds a statistically significant and positive relationship between real deposit interest rate and financial savings as well as between bank credit and financial savings, the net effect of a real deposit rate on investment is found to be negative. In other words, holding all other variables constant, a higher real deposit rate which leads to a higher increase in financial savings and then bank credit, is offset by a higher cost of lending, thus making the net effect on investment negative. In this regard, the findings do not seem to provide support for the McKinnon-Shaw financial liberalization hypothesis. Other variables found to be important in explaining investment in Ghana are the financial deepening, macroeconomic volatility that is proxied by inflation differential and the lagged change in GDP, affirming the accelerator model principle. The findings therefore have important policy implications for the on-going financial sector reforms.

Date: 2012
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