In order to establish the short-run relationships, we re-estimated equations (1) and (2) but this time on the differenced terms of the variables, including lags of the residuals from the levels regressions as explanatory variables. The inclusion of the lagged residuals is to determine the adjustment mechanism to the long-run. The coefficient of this error-correction term should be negative and statistically significant in order to support our earlier findings that there is cointegration. This is in fact a more powerful test for the presence of cointegration.
Equation (1) is reestimated as follows:
DLogREALM2 = C + a1DlogRGNPMl + a 2Dlog(IRATE) + a3D(RDPR) + a 4DMMY+
asRESID(-1) + a6Dlog(INFL) + U1 ... (la) Where all the terms are as defined above, and
RESID(-1) = lag of the residuals from the levels equation D = first difference of the series
Following the same procedure, equation (2) is estimated as follows:
Dlog(GDSRATE) = C + a1D(GRATE) + a 2D(RDPR) + a3Dlog(DPNR,2) + a4DMMY + asRESID(-1) + a6Ut ... (2a)
The results from the dynamic money demand and saving functions are presented in the table in the next page (table 4.5).
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Table 4.5: Difference Regressions for Domestic Savings and Money Demand
Functions, 1973-1997
Money Demand Domestic Savings
Function Function
Variable Coefficient Variable Coefficient
DLOG(RGNPM1) 0.90 (5.20) D(GRATE) 0.15 (5. 93)
D(RDPR) -0.006 (-4.2) DLOG(DPNR(-2)) -148.86 (-2.966)
DLOG(INFL(-3)) -0.06 (-3.17) D(RDPR) 0.018 (2.35)
AR(1) -1.39 (-6.16) AR(l) -0.66 (-3.57)
AR(2) -0.57 (-2.53)
RESID(-1) -0.86 (-4.77) RESID(-1) -0.91 (-3.12)
R2=0.78 DW = 1.997 R2 = 0.72 DW= 1.60
R2(Adj .)=0. 70 F=10.00 R2(Adj).=0.61 F=6.49
P(F)=0.00031 P(F)=0.008
4.5.1 Interpretation of the Error Correction Models
Dynamic Money Demand Function (Equation la)
ln the short-mn, the scale variable, real GNP (logRGNPM1), still has a positive impact and this is similar to the long-mn equilibrium money demand function. The variable is significant at the
1% lev el.
The change in real interest rate has a negative impact on the demand for money in agreement with Keynesian theoretical postulates and the variable is significant at the 1% level. It means that even in the short-mn, the real interest rate can be a useful policy instrument to affect money demand in The Gambia. The rate of inflation change, where inflation is lagged three periods, also has a negative sign and significant at the 1% level.
The lag of the residual from the levels regression was also introduced as an explanatory in the dynamic functi~n in order to investigate further the presence of cointegration. Since the coefficient of this lagged residual is negative and statistically significant, the more powerful test has supported the existence of cointegration between money demand and the determinants used in this modeL The coefficient of -0.86 means that following a short-mn distortion, 86% of adjustment to the long-mn takes place within one period either by market mechanisms, govemment intervention or a combination ofboth.
The F-statistic of 10.00 also demonstrates that the variables are jointly significant and the coefficient of determination of 70% is a good fit especially in a short-mn /dynamic situation. In
the long-run, there will be adjustment mechanisms to bring about equilibrium; 86% of adjustment takes place within one period following a short-mn distortion as shown by the coefficient of the error-correction term. The Durbin-Watson statistic of 1.997 (approximates to 2) also shows that the dynamic money demand equation has no evidence of first-order seriai correlation. This was eliminated by the introduction of AR(l) in the equation. The Breusch-Godfrey seriai correlation test (see table 4.5.1, page 73) also confirmed this finding and went further to suggest the absence of higher-order seriai correlation as shown in annex (technical annex 1).
The Dynamic Domestic Savings Function (Equation 2a)
In the short-run, the change in the dependency ratio still carried the theorized negative sign on domestic savings mobilization in The Gambia and significant at the 5% level. The real interest rate change was also positive and significant at the 5% level.
The real income (GDP growth) rate is still significant at the 1% level and has the theorized positive impact' on savings. This further buttresses the point that in developing countries, it is incarne more than the real interest rate that determines savings.
The lagged residual from the levels regression (the error-correction) is negative and statistically significant at the 1% level and hence one may safely conclude that there is cointegration between domestic savings and its determinants in this model. Conducting cointegration analysis between apparently correlated I(1) series (or any non-stationary series for that matter) and finding cointegration validates the regression. Failing to find cointegration, on the other hand, is an
indication that ~purious correlation may be present, and thus the invalidity of inferences drawn from such correlation. The coefficient of the error-correction term shows that 91% adjustment talees place within one period following a short-mn disturbance.
Diagnostic tests were also conducted for the above dynamic equations and as can be seen from the tables below and detailed explanation in technical annex 1, the models built have passed the six basic tests presented. The interpretations in the long-mn equilibrium models in the previous sections are therefore still valid.
To conclude, it should be noted that in the spirit of the methodology described here we conclude that the models are satisfactory and can be used for policy analysis and for forecasting. The adequate performance of these specifications against such a battery of diagnostic tests is a necessary, but not sufficient condition for accepting the models. These tests are simply designed criteria, and ultimately the models can be maintained only to the extent that they continue to explain out-of-sample data and to encompass rival models.
Table 4.5.1 Diagnostics Tests Results for Equation la
Type of Test F-Statistics Probability
Breusch-Godfrey(SCLM) 0.004 0.95
Jarque-Bera (Normality) 4.45* 0.1
ARCH(LM) 0.48 0.63
White Heteroschedasticity 0.70 0.69
Ramsey RESET 0.33 0.57
Chow Forecast ** 0.04 0.99
*the Jarque-Bera Statistic
** forecast is from 1994 to 1997
Table 4.5.2. Diagnostics Tests Results for Equation 2a
Type of Test F -Statistics Probability
Breusch-Godfrey(SCLM) 0.33 0.72
Jarque-Bera (Normality) 1.2* 0.54
ARCH (LM) 0.47 0.64
White Heteroschedasticity 2.15 0.18
Ramsey RESET 0.3 0.75
Chow Forecast ** 1.75 0.26
*the Jarque-Bera Statistic
** forecast is from 1996 to 1997
SUMMARY AND POLICY RECOMMENDATIONS
This final section presents a summary of the study and concluding remarks, followed by po licy implications and then policy recommendations based on the empirical findings.
Summary
The main objective of the study was to determine the role of the real interest rate on the demand for real money balances and domestic savings in The Gambia. A working hypothesis for this study is that the real interest rate variable has a positive impact on domestic savings mobilization in The Gambia and that the interest rate liberalization policy has destabilized the money demand function.
In chapter one, the structural adjustment programme was highlighted in arder to point out the
place and positioning of the interest rate liberalization policy in the overall programme. In chapter two, a thorough literature review was undertaken in arder to point out very clearly the theoretical bases of the arguments and justifications for the choice of regressors in examining the
interest rate liberalisation hypothesis. This was followed in the same chapter by an empirical literature review to show how thinking/views over the issues of interest liberalization policies and money demand estimation have evolved over time. Based on the theoretical background and empiricalliterature review, a method of analysis was adopted and presented in chapter three.
In chapter four, the real demand for money was regressed on real GNP, real deposit rate, investment rate the rate of inflation and a dummy variable representing the shift in government
'
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policy. All the variables were in logs except the real deposit rate. The series in this equation were tested for the presence of a unit root using the ADF class of unit root tests. The results show that all the series w~re integrated of order one. The domestic savings rate was also regressed on the real deposit rate, real GDP growth rate, foreign savings rate, the dependency ratio and the dummy variable representing the adjustment programme (policy shift dummy). Again, the results show all the series in this equation are integrated of order one except the dependency ratio and the foreign savings rate which are I(2) series. The impact of the real interest rate on domestic savings was found to be important and significant at the 5% level in line with the financial liberalization thesis. On the other hand, the impact of the real interest rate on the demand for real money balances was negative in line with Keynesian theoretical expectations but contrary to the postulates of the financialliberalization hypothesis.
To evaluate the impact of the economie recovery programme on domestic savings mobilization as far as the real interest rate was concemed, the dummy variable was temporarily removed from the savings equation. The equation without dummy representing financial repression in The Gambia showed the interest rate to be insignificant with a reduced coefficient (0.014). When the dummy was introduced the coefficient increased to 0.035 and the variable became significant.
The policy implication is that adjustment (financialliberalization) matters for domestic savings mobilization.
R egresswns were · came ou · d t on the levels and the residuals from each equation tested for stationarity. The higher ADF absolute values than the Mackinnon critical values confirmed that
there was cointegration in both models. This validates the tw o regresswns an 1s an md1catwn · d · · · · that spurious regression as a major statistical problem is absent in each of the models. In fact this was further confirmed by a more reliable test i.e. the error-correction terms on the dynamic equations ((la) ·and (2a)) were negative and statistically significant. This also shows that there would always be adjustment mechanisms to the long-run following a short-mn distortion.
Chapter four also deals with the diagnostic tests, which, taken together, show that the models did
not violate the basic assurnptions of the Ordinary Least Squares. The diagnostic test results (Chow in particular) shows that the money demand function was stable over the scope of the study and the change in policy did not cause instability.
Policy Implications and Recommendations
The chapter on empirical analysis has led to sorne policy implications as far as domestic savings mobilization and demand for real money balances in The Gambia are concemed. One major implication is that since data on monetary aggregates and domestic saving and their determinants are non-stationary as shown by the ADF class of unit roots test, any regression on them that fails to find cointegration must be only spurious and correlated and causation is not necessarily validated. Thus the cointegration and error-correction approach is, in our view, a preferable methodology that can give reliable parameter estimates necessary for policy analysis purposes.
Thus any methodology that fails to adopt this approach might very likely be unreliable. This
77
being so, regression results that assume these series are stationary must be viewed/ interpreted with maximum caution.
Another policy implication of the study is that interest rate liberalisation matters for domestic savings mobilization in The Gambia and maximum efforts should be made to make sure that all the pre-conditions required for financial liberalisation to yield the desired results are in place.
Similarly, income has a strong, positive and significant impact on domestic savings mobilization in The Gambia. As a result, the policy implication is that concrete efforts should be made to increase rural incarnes especially and make saving facilities available to them so that mobilization of domestic savings would be increased. In addition, the poverty alleviation activities through the Strategy for Poverty Alleviation Coordinating Office (SP ACO) should be given proper attention.
One major policy implication of the study is that high dependency in The Gambia is likely to frustra te ali efforts to mobilize domestic savings unless action is taken. As a result of this, fran tic efforts should be made in order to bring this dependency ratio down. In addition although the demand for money is still stable, this can only be maintained if the graduai speed (gradualist, learning-curve approach) of the reforms are maintained.
Based on the above policy implications, the study presents the following policy recommendations for consideration. It is hoped that if these measures are taken, it would go a long way in yielding the desired benefits of financial liberalisation, while at the same time avoiding its negative consequenses.
Domestic Savings Mobilization and Dependency Ratio
For domestic savings mobilization, the dependency ratio, although not a policy variable as such, has been found to exert a significant and negative impact. It is expected that the family planning activities being put in place, in order to reduce the alarming population growth rate of 4.2% per annum, would go a long way in ameliorating this. The government and even the private sector (NGOs) should be fully committed to enlarging the scope of family planning services and ensuring the integration of these services into the primary health care system.
If the literacy rate for women and girls is increased, the fertility rate and consequently the dependency ratio, could be reduced. This would positively impact on domestic savings mobilization for investment, economie growth and development.
lncome Growth and Domestic Savings Mobilization
The positive impact of the real income variable was also established by the study as per Gambian data. As a result of this, the study suggests that concrete efforts be made towards enhancing rural incomes and savings facilities made available to them so that the process of domestic savings mobilization for investment would be increased. Sorne of such efforts include rural infrastructure development, agricultural input subsidies and extension services, improvements in education, health and other social indicators.
1
1 1
1
il
:/
1
The Real Interest Rate and Domestic Savings
The role of the real interest rate was also found to be positive and significant in domestic savings mobilization. In view of this, acting on the real interest rate would help increase domestic savings mobilization. Thus in order to continue to keep real interest rates positive, the determination of this should to a large extent be left to market forces. In relation to this, the important efforts made towards priee stability should be maintained and where possible strengthened. In order to do this, budget deficits, the monetization of which leads to priee instability and high inflation rates, should be minimized as a matter of public policy. If high budget deficits are monetized (monetary accommodation of the budget deficit), the very probable inflationary consequenses would bring the real interest rate down thus reducing domestic savings mobilization. Greater autonomy of the central bank could help avoid this eventuality. The study recommends that fiscal deficits be kept on or below 3% of GDP. Thus extra-budgetary expenditures should be limited and where possible eliminated completely. The sinking fund, which is an important recipe for extra-budgetary expenditures in which unnecessary expenditures are kept, should be properly monitored.
The study also found that the policy shift dummy was positive and significant on domestic savings mobilization. Thus the other accompanying measures of the structural adjustment programme such as privatization of state-owned enterprises, should continue as these can positively enhance domestic savings mobilization in The Gambia. Public enterprise reforms should be strengthened by continued use of performance contracts and memorandum of
understanding in order to promote efficiency. This would enable these strategie enterprises to meet their financial obligations to the government. In particular, closer attention should be paid to the only loss-making public enterprise (Gambia Public Transport Corporation) to reverse its financial standing to a break-even or a marginal profit-making enterprise. For loss-making enterprises, their pricing structures could be adjusted, their employment policies revisited and capital programmes rationalized. The establishment of cost centres and a more autonomous managerial authority to pursue the most efficient delivery of services and linking managers' remuneration to performance should be established.
Financial Sector Reforms
The demand for money function was found to be stable over the period of the study. In order for
this to be maintained, it is recommended that the slow (graduai) speed of the financial sector reform should be adhered to. Haste would destabilize this function and :frustrate monetary policy execution in The Gambia.
Banking Supervision Regulations
It should be noted that the study and the policy recommendations thus provided assume effective
banking supervision conducted by an efficient banking supervision department at the central bank. There should be clear and user-friendly prudential and banking supervision rules and regulations.
81
There should be more focus on accelerated write-offs of long-standing bad loans and increased provisioning in order to achieve maximum compliance with the supervisory regulations. Added to this, the central bank should, as a matter ofregulatory policy, agree with banks on a short-term programme, to puild provisions. Appropriate penalties, such as limiting the access to rediscount facilities, should be executed judiciously for those banks that fail to comply with the provisioning regulations and capital adequacy requirements.
The staff of the banking supervision department at the central bank should be expanded in both quantitative and qualitative terms in order to increase accuracy and frequency of supervision.
The study suggests at least once a year of on-site examinations of commercial banks, which should be held according to a fixed timetable.
Furthermore, to simplify bankruptcy and collateral liquidation procedures, the commercial chamber in the High Court earmarked should begin operations as soon as possible. Finally, the central bank should also develop a prudential regulatory :framework for the insurance industry.
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