McKinnon-Shaw financial liberalization hypothesis in Ghana: Evidence from linear and non-linear autoregressive distributed lag approaches

The capacity of inflation targeting (IT) policy to consolidate gains from financial liberalization in developing countries has been questioned, particularly after real interest rates have been driven to a negative territory following COVID-19’s inflationary pressures. In this study, we examine the role of Bank of Ghana’s IT policy in moderating the real interest rate-saving nexus analysed through the lens of the McKinnon-Shaw Hypothesis (MSH), which posits that maintaining real interest rates in a reasonable positive range would stimulate saving and investment rates in developing countries. We apply linear autoregressive distributed lag (ARDL) model to time series data spanning 1986-2023, augmented by non-linear ARDL analysis. Results show that IT policy strengthens the positive impact of real deposit interest rate on financial saving in the long run. The study, however, finds no stable long-run relationship between real interest rate and financial saving as there prevails only a short run nexus, suggesting that the MSH might be delayed than implied by theory. Further analysis reveals that the saving-real interest rate relationship is characterised by asymmetry in the short run, with saving responding more strongly to negative than positive levels of real deposit interest rate. The study’s findings highlight the importance of maintaining strong commitment to low and stable inflation for successful financial liberalization. The findings again suggest that the central bank of Ghana should be mindful of the asymmetric effects of real interest rates when adjusting the policy rate in response to shocks.