Financial Innovation and Money Demand in Sierra Leone

Abstract

Economists have long recognized that stability in the money demand function is a precondition for effective monetary policy formation and implementation. In recent decades, many countries have experienced different forms of financial innovations that have one way or the other affected the stability of money demand. Sierra Leone is not exempted, considering the rapid growth of financial innovations in the country over the past years. This study adopts the Autoregressive Distributive Lag method to examine a money demand function for Sierra Leone that includes financial innovation and test its stability for the period 1966 to 2016. The long-run empirical findings indicate that real income, financial innovation and foreign interest rate directly impacts real broad money, whereas the impact of the civil war is negative. Moreover, inflation, financial innovation and foreign interest rate are inversely related to real broad money in the short-run. The short-run findings also confirm the existence of wealth effects. Lastly, the test for parameters stability test points to a stable estimated model, suggesting monetary policy has been effective.