Effect of Financial Innovation on Money Demand in the East African Community

Abstract

Tremendous financial changes have been witnessed in the East African Community’s (EAC’s) macroeconomic landscape over the past few years. These changes can shift various parameters of the money demand model. Many previous empirical studies examined the effect of scale and opportunity cost of holding money variables on money demand. However, most of them left out financial innovation which is one of the key factors influencing money demand. Additionally, they are just country specific studies and used time series data analysis technique. It is in this backdrop that a cross-country case study that investigates how financial innovation affects money demand function was carried out using the recent data and a different analysis technique which is panel data analysis. The objective of the study was to examine the effect of mobile financial innovation on money demand in the EAC. The study used secondary data for the period 2007 to 2020 and this data was obtained from the World Bank and International Monetary Fund. Both descriptive and inferential analyses were carried out. Levin-Lin-Chu test for panel unit root was done and all the study variables were found to be stationary at level. The results of balanced panel fixed effects regression analysis indicated that mobile money, ATMs, and real GDP were affecting money demand positively and their effects were also statistically significant. However, interest rate affected money demand negatively. Mobile money and ATMs were proxies for financial innovation whereas real GDP and interest rates were control variables. Therefore, it was observed that financial innovation has had a positive effect on money demand in the EAC. The findings of this study might be of great importance to monetary authorities and policy makers in the EAC. Future research studies can expand the period of study similar to this one and also increase the number of countries involved.