The effect of financial innovation on money demand in Uganda: An examination of new transaction technologies on demand for narrow money

Abstract

This study investigated the effect of financial innovation in form of new transaction technologies on demand for narrow money (M1) in Uganda. In particular, it assessed the individual effect of automated teller machines (ATMs) and electronic funds transfers (EFTs) on demand for narrow money. Monthly aggregated data from June 2003 to March 2011 was employed and a Johansen Juselius approach to cointegration revealed a long-run relationship among the variables. It was established that both ATMs and EFTs increased money demand. The income elasticity of money demand was positive and the interest rate and expected inflation had a negative effect. The Treasury bill rate, however, had a smaller coefficient than expected inflation suggesting that individuals have preference for investment in real assets than financial assets. The positive effect of ATMs and EFTs indicate that there are welfare gains from faster transactions involved. To that end, they contribute to trade, the deployment of resources and the rate at which money exchanges hands. Aside from contributing to economic growth, this has a bearing on the speed at which monetary actions are transmitted to the real economy. More investment is therefore recommended in the payment system to promote financial inclusion and to increase the diffusion of new payment media to a level where the benefits from the low costs of transactions outweighs the fixed cost of capital involved.