The Shaw and Mckinnon hypothesis as highlighted above has sparked a number of studies geared primarily towards investigating empirically, the proposition with regard to savings, investment, growth and financial development/deepening. For the purpose of this paper, the impact of the policy on domestic savings and money demand , as highlighted above would be examined.
Fry in 1978 undertook a study of seven Asian countries using pooled time series analysis on annual observations. He estimated a domestic savings function by two-stage least squares with country dummy variables method (TSLSDV). The savings rate was regressed on the real growth rate, real per capita income, foreign savings as a ratio of GNP, the real interest rate and the domestic savmgs rate lagged one period. His main emphasis here was on the relationship
between the domestic savings rate and the real interest rate. The impact of the real interest rate was positive and significant and he concluded that positive real interest rates do indeed matter for domestic savings mobilization for investment. However, Fry did not subject the variables used to stationarity and cointegration tests, which we think would have improved his important findings. Again the demographie factor was not taken into account and our study intends to fill this gap.
In 1984, Yusuf and Peters did a similar study on Korea but estimated the aggregate savings function using Ordinary Least Squares (OLS) technique. They regressed aggregate savings on current income, permanent income, growth rate of income, rate of inflation, foreign savings and the real interest on time deposits.
Their regression results indicated that all the estimated equations performed well in terms of standard error of regressions, which ranged from 0.06 to 0.087. They concluded that a 10%
increase in the real interest rate on time deposits would raise gross savings6 by 11.57% and gross domestic savin~s by 5.03%. The policy implication is similar to that of Fry's that financial conditions (high interest rates) impact positively on aggregate savings performance.
In their study of six West African countries Leite and Makonnen (1986) estimated a private savings function by the weighted least squares method, using normalized variables which were corrected for heteroscedasticity. Their private savings function was regressed on disposable income, real interest rate, exports as a proportion of GDP and the lagged dependent variable.
6 Gross Savings = Gross domestic Savings + Foreign grants and Private transfers 29
Here again the _impact of the real interest rate was positive and significant and they concluded that high real interest rates matter for overall private savings mobilization.
The study by Oshikoya (1992), on Kenya, makes a particularly interesting literature in the sense that it was done within the context of a Sub-saharan Afican country. Oshikoya examined in this study the extent to which theoretical propositions supporting the role of financial factors in economie development explained the performance of domestic savings rate, demand for liquid assets, credit availability, private investment and economie growth . In this study, he replicated the methodolog:y of de Melo and Tybout (1986) applied in a cognate study of the Uruguayan economy.
The Saving function was estimated as follows : DSt= f (G, R, FSR, DSt-I), where
DSt = Ratio of gross domestic savings to GDP G = Growth rate of GDP
R = Real interest rate
FSR =Ratio of foreign savings to GDP
DSt-!= One-period lag of the dependent variable
This function was estimated in order to test the hypothesis of a positive relationship between the real interest rate and savings in the context of a Sub-Saharan African coutry like Kenya.
The money demand function was estimated as below : Mt ct= f ( GDP, R, PIR, Mt}) where
Mt = Real demand for money d
GDP =Real gross domestic Product R = Real deposit rate
PIR = Private Investment Rate Md1_1 = Lagged Real Money Balances
In this function, Oshikoya tested the proposition that higher real interest rates increased the incentives to save by means of bank deposits and also the complementarity between money and capital.
The credit availability effect on investment was also presented through the following two functions:
(a) DCt = f(PCI, R, DCt-1)
where
DCt= Domestic Credit PCI = Per Capita Income R = Real Interest Rate
DCt_1= lagged Domestic Credit
This function was specified to investigate the existence of the posited positive relationship between real interest rate and domestic credit availability (from where investment is influenced).
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(b) The financial repression hypothesis also posits a positive relationship between real interest rate and private investment. The private investment function was estimated to capture this effect.
PI= f(G, R, 8TOT, PUIR, DSRt_1, CPI) where PI = Ratio of private investment to GNP G =Real GDP growth rate
8TOT = Terms oftrade changes
DSRt-1 = lagged debt service ratio PUIR= Public investment rate CPI = Cçmsumer priee index
To capture the growth effect of real interest rate changes, the real growth function was estimated in the following form:
GR= f (R, TIR, CPI)
where
GR= Real growth rate of GDP R = Real deposit rate
TIR= Total investment rate CPI = Inflation rate
The results Oshikoya obtained can be summarized as follows:
(i) The positive impact of the real interest rate on domestic savings was validated ( although
(ii) The impact of the real interest rate on the demand for money was negative but statistically insignificant, contrary to the financialliberalization theory, which suggested a positive relationship. However, the negative sign was in line with Keynesian postulates.
(iii) For investment, he tested firstly, that higher real interest rates increase availability of domestic credit by regressing the ratio of credit to the private sector to GDP on real deposit rate, log of per capita income and lagged value of the dependent variable. The result indicated that real deposit rate exhibits a small, positive, but insignificant correlation with credit.
(iv) The regression with private investment showed that the real interest rate has a positive and statistically significant effect on private investment.
(v) On economie growth, the empirical proposition tested was that real interest rates promote economie growth. The real economie growth rate as shown above was regressed on aggregate investment rate, real deposit rate and the inflation rate. The estimated equation
performed well only during the period of liberalization. Output growth rate was positively correlated with investment.
On the other hand, a handful of other studies did not favour the Mckinnon and Shaw hypothesis of financial liberalization. Among these we can single out a study conducted by Argawala (1983), Lanyi and Seracoglu (1983). These authors found that a relatively high growth rate of output can co-exist side-by-side with negative real interest rates. Recognizing the fact that the
stimulus for growth could emanate from other exogenous factors, it was noted that negative real interest rates did not always have the adverse effect on economie growth as the hypothesis seems to suggest. Again several studies have found no direct relation between the level of savings and the interest rate (Chandavakar 1971, Mikesell and Zinser 1972, Brown 1980). Similarly, inconclusive results have been encountered in studies of investment ( Sundararajan and Thakur 1980, Roe 1982).