A Nonlinear Approach to the Analysis of the Financial Innovation-Money Demand Nexus in Nigeria

Abstract

This study examines the asymmetric roles of financial innovation in the money demand function in Nigeria using annual data over the period 1981-2020. This is with a view to providing insight into how changes in financial innovation have contributed to the level and stability of the money demand function. The study questions the fundamental assumption of the existing literature that growing trends in financial innovation have symmetric or linear effects on the country’s money demand. Hence, it adopts the nonlinear autoregressive distributed lag (NARDL) with bounds testing procedure together with the cumulative sum of recursive as well as the cumulative sum of squares of recursive residuals tests. Results show that the link between financial innovation and money demand is asymmetric and that of the two partial sum variables, only positive changes in financial innovation have significant effects with the sign being positive in both the short run and long run. This shows that assumptions of linearity and no asymmetric structure reported in extant studies for financial innovation are somewhat misleading. Findings also confirm the stability of demand for money in Nigeria on account of the introduction of asymmetric effects of financial innovation. The study concludes that the financial innovation-money demand nexus is asymmetric and that there is stability in the country’s money demand function once asymmetry or nonlinearity is captured in the nexus. Therefore, it recommends the need for monetary authorities to pay attention to positive changes in financial innovation when policies on money demand are formulated for the purpose of enhancing the effectiveness and reliability of monetary policy as a tool for stabilising the economy.