The role of inflation targeting policy in the McKinnon-Shaw financial liberalization hypothesis in Ghana: Evidence from linear and non-linear autoregressive distributed lag approaches

The shock-absorbing capacity of Ghana’s inflation targeting (IT) policy has been under scrutiny, especially following COVID-induced inflationary pressures that drove real interest rates to a negative territory with implications for saving. This study examines IT policy’s role in moderating the real interest rate-saving nexus through the lens of the McKinnon-Shaw Hypothesis (MSH), from the perspective of private savings’ adaptation to real interest rate fluctuations. The study applies linear autoregressive distributed lag (ARDL) model to time series data spanning 1986-2023, augmented by non-linear ARDL analysis. We uncover no stable long-run relationship between real deposit interest rate and private financial saving as there prevails only a short run nexus. This finding suggests that the MSH might be delayed than implied by theory, which is likely due to asymmetric responses in the saving-interest rate nexus with positive and negative interest rates affecting saving differently. Results indicate a short run positive nexus between financial saving and negative real interest rate, while the relationship between positive real interest rate and saving is insignificant. IT policy, however, strengthens the relationship between saving and real interest rate over the long run, indicating that further strengthening of the policy could address asymmetric responses in the saving-interest rate nexus and help realize the MSH.