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

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  • Eric Osei-Assibey
  • William Baah-Boateng
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.

Suggested Citation

  • Eric Osei-Assibey & William Baah-Boateng, 2012. "Interest Rate Deregulation and Private Investment: Revisiting the McKinnon-Shaw Hypothesis in Ghana," The IUP Journal of Applied Economics, IUP Publications, vol. 0(2), pages 12-30, April.
    • Handle: RePEc:icf:icfjae:v:11:y:2012:i:2:p:12-30
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    Cited by:

    1. Clement Moyo & Pierre Le Roux, 2019. "Interest Rate Reforms and Economic Growth in SADC Countries: The Savings and Investment Channel," Scientific Annals of Economics and Business (continues Analele Stiintifice), Alexandru Ioan Cuza University, Faculty of Economics and Business Administration, vol. 66(4), pages 507-523, December.
    2. Kizito Uyi Ehigiamusoe & Mohamad Shaharudin Samsurijan, 2021. "What matters for finance‐growth nexus? A critical survey of macroeconomic stability, institutions, financial and economic development," International Journal of Finance & Economics, John Wiley & Sons, Ltd., vol. 26(4), pages 5302-5320, October.

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