The Interaction Effect of Financial Innovation and the Transmission Channels on Money Demand in Uganda

The current study set out to examine the direct as well as the indirect effect of technological advances and diversification of the financial sector on money demand in Uganda using annual data from 1986 to 2017. The results derived on the basis of the ARDL framework provide evidence in confirmation of the significant role played by financial innovation in the demand for real narrow money balances both directly and indirectly via the real income as well as the inflation rate channels in the shortrun and longrun. The association appears to increase (decrease) once inflation (real income) decreases (increases). On the contrary, we find no evidence that the exchange rate and the interest rate channels matter in the financial-innovation-money-demand linkage although their independent effect is significantly indismissible. Surprisingly, besides the exchange rate and inflation rate, data does not allow conclusion of any significant role of financial innovation in real broad money balances. Finally, the money demand function is found stable over the study period. Overall, supportive policies that are pro-advancement in the creation and popularizing of the new financial instruments as well as new financial technologies, institutions and markets are strongly recommended for purposes of enhancing pro-growth financial innovations. Policy makers ought to give more attention to the income and inflation rate transmission channels if financial innovations are to be a benefit rather than a risk to money demand stability. The adoption of the inflation lite monetary framework was therefore a right step in the right direction.