Effect of Financial Innovation on the Demand for money in Ghana

Abstract

The study examined the effect of financial innovation on the demand for money in Ghana. Specifically this study examined the long run and short run relationships between financial innovation, real income, interest rate, price level, real effective exchange rate and demand for money; tested for the stability of the demand for money function and established the direction of causality between innovation (and other regressors) and the demand for money in Ghana. The study employed quarterly time series data from 1983(1) to 2012(4) for Ghana and used the Autoregressive Distributed Lag (ARDL) approach to cointegration. The study also employed the Principal Component Analysis to construct an index of financial innovation. The regression results showed that in the long, financial innovation, real income, and price level had positive effect on narrow and broad money demand whiles interest rate and real effective exchange rate had negative effect on narrow and broad money demand in Ghana. The short run results also revealed that real income (both current and previous values), and price level, and financial innovation had positive effect on narrow and broad money demand whiles interest rate (both current and previous values) and real effective exchange rate had negative effect on narrow and broad money demand in Ghana. The narrow and broad money demand functions are also to be stable over the study period. It is therefore, recommended that government provides incentives to facilitate the improvement of financial innovation and constantly reassess the stability of the demand for money in line with financial innovation.