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Definitions and Sources of Variables
Economist at the International Finance Corporation. The author thanks Anupam Basu, Francesco Caramazza, Alain de Crombugghe, Neil Ericsson, Mark Henstridge, Ernesto Hernández-Catá, Gunnar Jonsson, Fred Joutz, Godfrey Kalinga, Arend Kouwenaar, Mwanza Nkusu, Cathy Pattillo, Paul Reding, Scott Rogers, Emilio Sacerdoti, Thomas Walter, and seminar participants at the IMF’s African Department and at the Central Bank of Congo (the latter seminar organized by the Central Bank Governor, Jean-Claude Masangu) for helpful comments and discussions. The usual disclaimer applies.
Between 1970 and 1986, per capita real GDP fell by more than 30 percent.
On an annual basis, inflation averaged 179.5 percent over 1985-88, against 41.5 percent over 1982-84.
Annual inflation averaged 45.3 percent and 8 percent during 1988-92 and 1993-97, respectively. In 1998, the inflation rate was barely zero percent.
Throughout the 1970s and most of the 1980s, nominal interest rates were kept well below the level of inflation, as the BOU conducted monetary policy with a view to speeding up economic development through credits to specific “priority” sectors.
Prior to Uganda’s liberalization of interest rates in April 1992, treasury bill auctions were used as a means to finance fiscal operations through the nonbank public (Sharer and others, 1995).
These included the generation of updated and accurate balance sheets of financial institutions; removal of restrictions imposed on commercial banks’ operations and asset holdings (such as foreign transactions and treasury bills); strict compliance with statutory reserve requirements by commercial banks; elimination of preferential rates and directed credits to priority sectors (mainly agriculture, manufacturing, trade, and commerce); restructuring of the Uganda Commercial Bank; higher capital requirements; and elimination of entry barriers into the banking industry. See Kasekende and Atingi-Ego (1999) and Brownbridge(1998).
Until 1993, the cash reserve requirement was set at 10 percent of deposit liabilities (Brownbridge, 1998). However, this instrument was ineffective for monetary control because banks had automatic access to the BOU lending facilities whenever they faced liquidity constraints. In 1998, Uganda had a reserve requirement of 9 percent of demand deposits, 8 percent of time and savings deposits, and 20 percent of foreign currency deposits. However, banks are allowed to average reserves over a two-week maintenance period, and penalties are imposed for noncompliance (Mehran and others, 1998).
The conventional idea is that, in developing countries, where interest rates ceilings and capital controls prevail, asset substitution is likely to be between money and physical assets rather than between money and financial assets. This assumption does not hold in Uganda over the sample period covered, as a statistically significant role is found for the treasury bill rate in the long-run analysis, while inflation affects only the short-run dynamics.
M stands for the nominal money supply. It is assumed that in the long run, the money market is in equilibrium: the money supply (M) deflated by the price level (P) is equal to the real demand for money (Md/P).
GDI is GDP with the impact of changes in terms of trade on net export receipts added. See Henstridge (1999, p. 354 and pp. 376-77) for the construction and primary source of this series.
Working with equation (2b) instead of (2a) offers the empirical advantage of reducing the number of parameters to be estimated and thus provides a gain in terms of degree of freedom. The assumption of an equal semielasticity (in absolute value) for DEPO and TBILL is tested for and confirmed in the next section. It is also shown later that the holding of this assumption does not necessarily imply that domestic bank deposits and treasury bills are perfect substitutes.
Other authors have referred to these two theories as the “fiscal-monetarist view” and the “balance-of-payments school.” See, for instance, Montiel (1989).
j denotes lag. If the consumer price index is I(2), then the dependent variable is specified in terms of acceleration of inflation (second difference of the logarithm of the consumer price index).
This channel depends crucially on finding a money demand function that is sensitive to rates of return on both domestic and foreign financial assets. This is shown to be the case in Uganda over the sample period covered.
The definition of M2 adopted in this paper is the IMF International Financial Statistics one, that is, money plus quasi money. It differs from the M2 aggregate used in Atingi-Ego and Matthews (1996) and Katarikawe and Sebudde (1999) as it includes foreign currency deposits.
Throughout this paper the optimal lag length of the VAR is chosen on the basis of the Schwarz-Bayesian criterion, as well as on the residuals’ being white noise. Also, unless otherwise indicated, all models tested for cointegration contain seasonal dummies and a trend. The seasonal dummies are entered unrestricted while the trend is entered restricted.
Most important, the vector test does not reject the null hypothesis of normality.
Throughout this paper, asymptotic p-values are presented in square brackets following the observed chi-square statistics.
Under the assumption of PAS, however, weak exogeneity is rejected for LIBOR.
For instance, the likelihood ratio test for full-PAS evaluates whether (0.25*аз* 0.19) is, in absolute value, statistically not different from (0.25*a4* 0.23). Given that semi-PAS already holds, we are in fact testing whether the mean of DEPO (0.19) is statistically not different from the mean of TBILL (0.23).
Although individually I(1), the differential between DEPO and FMMR is found to be stationary, or, equivalently, the two interest rates are cointegrated with a coefficient that is not significantly different from unity. Nachega (2001) shows, however, that lagged changes in FMMR affect significantly (at the 10 percent level) the short-run dynamics of broad money demand.
The cointegration tests reveal the existence of two vectors: a money demand function and an IS curve. For the purpose of systems identification, LIBOR is excluded from the monetary sector, but enters the IS relation. DEPO and LIBOR are found to enter the latter equation with an equal semielasticity in absolute terms.
Developments exogenous to the financial sector, such as security problems (during the civil war), unattractive producer prices, and a very inefficient payments system, may have contributed to a fall in the demand for M1 during the 1980s. Public confidence was further undermined by the 1987 currency exchange, which imposed a tax of 30 percent on holdings of currency and bank deposits. See Henstridge (1999), Brownbridge (1998), and Sharer and others (1995).
Another indicator of financial depth is the ratio of currency to broad money. This ratio averaged 30.4 percent over 1992-98 compared with 39.5 percent over 1980-86.
t-values are in parentheses and “Δ” stands for the first difference of a specific variable.
Due to space considerations, the cointegration results underlying these two relations are not reported in this paper. The reader can rely on Figure 4 and Figure 6 to see why PPP and UIP hold. Nevertheless, the econometric results can be obtained by sending an e-mail to the author.
A 914 percent devaluation of the shilling (in nominal effective terms) in June 1981 may have affected the result of test in favor of strict PPP. The results of misspecification tests for this extended period—where strict PPP holds—are however problematic. This explains why the cointegrating vector derived from the restricted sample—where only weak-form PPP holds—are instead preferred.
LFD stands for natural logarithm of the financial deepening ratio.