Munich Personal RePEc Archive

Dynamic Impact of Money Supply on

Economic Growth in South Africa. An
ARDL Approach

Dingela, Siyasanga and Khobai, Hlalefang

Nelson Mandela University (NMU), Nelson Mandela University

(NMU)

10 November 2017

Online at https://mpra.ub.uni-muenchen.de/82539/
MPRA Paper No. 82539, posted 10 Nov 2017 13:08 UTC
 DYNAMIC IMPACT OF MONEY SUPPLY ON ECONOMIC GROWTH IN SOUTH
AFRICA: AN ARDL APPROACH

S. Dingela
Department of Economics, Faculty of Business and Economic Studies, Nelson Mandela
Metropolitan University, Port Elizabeth, South Africa, 6031.
And
H. Khobai
Department of Economics, Faculty of Business and Economic Studies, Nelson Mandela
Metropolitan University, Port Elizabeth, South Africa, 6031.

ABSTRACT: This study investigates the dynamic impact of broad money supply (m3) on
economic growth (GDP) per capita in South Africa using time-series data from 1980 to 2016.
The study has employed the autoregressive distributed lag (ARDL)-bounds testing approach to
cointegration and error correction model to investigate the impact of m3 on GDP per capita. The
model is specified with four macroeconomics variables, namely, Gross Domestic Product (GDP)
per capita, Broad money supply (M3), Interest rate (INT), Inflation rate (INF). The findings
reveal that there is statistically significant positive relationship between money supply and
economic growth both in short run and long run. The government of South Africa should
maintain consistency and follow “the Taylor1 rule” to allow money supply to increase at a steady
rate keeping pace with the economic growth. In respect to such rule will help South Africa
Reserve Bank to avoid the inefficiencies that caused by execution of discretionary policy.

Keywords: Economic growth; Money supply; Inflation rate; Interest rate; Autoregressive
Distributed Lag (ARDL).

JEL Classification Code: B22; C22; E51; E52; E58; O40

1
Taylor rule is a reduced form approximation of the responsiveness of the nominal interest rate, as set by central
bank, to changes in inflation, output, or other economic condition.
 1. Introduction

The impact of money supply on economic growth (GDP) per capita has received little
coverage in the literature of South African context. Most of the studies on the similar topic are
focused in other countries. Yet, it is equally significant to establish the impact of money supply
on economic growth in South Africa for policy makers to effectively harness and augment
economic growth.

The link between money supply and output has been getting increasing attention in recent
times for the importance role it plays in economic growth in the emerging and industrialized
economies (Hussan and Haque, 2017). Some Keynesians think that “money does not matter”,
hence irrelevant to influence economic growth, while in the other hand, some monetarists believe
that “money does matter”. However, the new Keynesians argue that in the short-run, changes in
the money supply seem to affect the real variables like GDP and employment levels because of
price-rigidity (Price-stickiness) and imperfect information flow in the market. (Hussan et al.
2017). Steve (1997) and Domigo (2001), explain that there may not be possibility of economic
growth without an appropriate level of money supply, credit and appropriate financial conditions
and general.

The South African economy has undergone a substantial transformation since the advent
of democracy2. It recorded an average rate of economic growth of 3.3 % per annum in real terms
over the period 1994 to 2012, a remarkable improvement on the 1.4% average annual growth
registered during the period 1980 to 1993. However, the pace of growth fell somewhat short of
the 3.6% average recorded by the world economy3. South Africa’s gross domestic product by
2012 was 77% larger in real term relative to 1994, with the corresponding increase for the global
economy having been 90%. On per capita basis, the country’s real GDP was 31% higher by the
end of the period. (Industry Development Corporation, 2013). Currently in South Africa the
strongest growth rate is with agriculture, forestry and fishing making the largest upward
contribution, namely field crops and horticultural products. GDP growth rate in South Africa

2
South Africans also elect provincial legislatures which govern each of the country's nine provinces. Since the end
of apartheid in 1994 the African National Congress (ANC) has dominated South Africa's politics.
3
The world economy or global economy is the economy of the world, considered as the international exchange of
goods and services that is expressed in monetary units of account (money).
average 2.84% from 1993 until 2017, reaching an all time of 7.60% in the fourth quarter of 1994
and a record low of -6.10% in the first quarter of 20094. On the other side, the broad money
supply (m3) in South Africa increased to R3 240 868 million in July from R3 206 208 million in
June of 2017. Money supply in South Africa averaged to R6464434.84 million from 1965 until
2017, reaching an all-time high of R3 240 868 million in July of 2017 and a record low of R4796
million in March of 19655.

Given the critical role money supply plays in pursuit of an economic growth, this study,
therefore seeks to investigate the dynamic impact of broad money supply on economic growth
with Autoregressive Distribution Lag (ARDL) approach to cointegration in South Africa during
1980 to 2016. The model is specified with four macroeconomics variables, namely, Gross
Domestic Product (GDP) per capita, Broad money supply (M3), Interest rate (INT) and Inflation
rate (INF).

The rest of the paper is set out as follows: Section two provides a brief review of
literature; Section three outlines estimation techniques. The fourth section presents the results
and analysis, while the fifth section concludes the study.

4
https://tradingeconomics.com/south-africa/gdp-growth
5
https://tradingeconomics.com/south-africa/gdp-growth
 2. Empirical Literature Review

The literature on the dynamic impact of money supply and economic growth is still at the
nascent stage in South Africa. Of the few studies that have attempted to analyze relationship
between money supply and economic growth, the results are mixed. Some studies have found
positive relationship between money supply and economic growth, while others have found
insignificant relationship between these variables.

Hussain and Haque (2017), researched about the empirical analysis of the relationship
between money supply and per capita GDP growth rate for Bangladesh, using vector error
correction model (VECM) model. They ascertain that the money supply has significant role on
the growth rate. The same results are proven by other researchers. Like Chaitipa,
Chokethaworna, Chaiboonsrib and Khounkhalaxc (2015), investigated the money supply
influence on economic growth for Authorized Economic Operators (AEO) open region in the
period 1995-2013, using Autoregressive Distribution Lag (ARDL) model. They found money
supply is associated with economic growth. Ogunmuyiwa and Ekone (2010), looked between
money supply and economic growth for Nigeria, employed error correction model over the
period 1920-2006. The results of their study depicts that money supply is positively related to
growth. Another research, focused on money supply, inflation and economic growth (Babatude
and Shuaibu, 2011). They found positive and significant relationship between money supply and
economic growth for Nigeria between 1975 and 2008 and employed ARDL model. Chude and
Chude (2016), also research the impact of broad money supply and economic growth for Nigeria
during 1987 to 2010 and they used ARDL model, their finding showed money supply and gross
domestic product are closely related. Mohammad, Wasti and Hussain (2009), investigated an
empirical investigation between money supply, government expenditure, output and price for
Pakistan for the period of 1977 to 2007, the econometrics model used was Johanson
cointegration model. They found that money supply (m2) is positively impact on economic
growth. Furthermore, Hameed and Amen (2011), investigated the impact of monetary policy on
gross domestic product (GDP), for Pakistan and they found growth in money supply greatly
affects GDP. Ihsan and Anjum (2013) examined the impact of supply (m2) and GDP for Pakistan
and they found money supply is affected by GDP.
Zapodeanu and Cociuba (2010) investigated linking money supply with the gross domestic
product for Romania over 10 year’s period, using Engle-Granger and ARIMA model. They
ascertain money supply and gross domestic product are in a close relationship. Maitra (2011)
investigated the anticipated money, unanticipated money and output variation for Singapore
during 1971 to 1972, using cointegration model. They found out money supply and output are
cointegrated. Aslam (2016) also investigated impact of money supply on economic for Sri Lanka
over the period 1959-2013, employed multivariate econometrics variable. He found that money
supply has kept positive impact on the economic growth.

On the other hand, there are few studies found statistical insignificant and negative
impact between money supply and economic growth. These studies are Adusei (2013)
investigated financial development and economic growth for Ghana over the period 1971-2010,
employed Fully Modified Ordinary Least Squared (FMOLS). They found financial development
(including money supply) undermines economic growth. These results were proven correct by
other few studies. Gatawa, Abdulgafar and Olarinde (2017), investigated the impact of money
supply, inflation on economic growth for Nigeria in the period 1973-2013 and they used VECM.
Their findings showed broad money supply and interest were negatively related to economic
growth. Another study attest on the same result was the paper of Ihsan and Anjum (2013)
examined the impact of money supply (m2) on GDP for Pakistan between 2000 and 2011, used
economic indicators and they found statistically insignificant and negative impact of money
supply on economic growth. And lastly, Ehigiamusoe (2013) researched about the link between
money markets and economic growth for Nigeria over the period 1980-2012, employed VECM.
He ascertains the link between the money market and real sector of the economy remains very
weak. Table 1 Summarises the studies that have investigated the impact of money supply on
economic growth and their findings.

Table 1: Summary of Empirical Studies on the Impact of M3 on GDP.

Author(s) Title Region/ Country Impact

Hussain and M. Empirical of the Bangladesh. Money supply has
Haque (2017). relationship between important on the
money supply and per growth rate.
 capita GDP growth
rate.
Chaitipa. et al.(2015). Money supply AEO open region. Money supply was
influence on associated with
economic growth. economic growth.
Babatunde, et al. Money supply, Nigeria. Positive and
(2011). Inflation and significant
economic growth. relationship between
money supply and
economic
Chude, et al. (2016). Impact of broad Nigeria. Money supply and
money supply on gross domestic
economic growth. product are closely
related.
Mohammad, et al. An empirical Pakistan. Money supply (m2) is
(2009). investigation between positively impact on
money supply; economic growth.
government
expenditure; output
and prices.
Hameed, et al. (2011). Impact of monetary Pakistan. Growth in money
policy on gross supply greatly affects
domestic product GDP.
(GDP).
Ihsan, et al. (2013). Impact supply (m2) Pakistan. Statistically
on GDP. insignificant and
negative relationship
between money
supply and economic
growth.
Aslam (2011). Impact of money Sri Lanka. Money supply has
 supply on economic kept positive impact
growth. on the economic
growth.
Zapodeanu, et al. Linking money supply Romania. Money supply and
(2010) with the Gross gross domestic
Domestic Product. product are in a close
relationship.
Maitra, (2011). Anticipated money, Singapore. Money supply and
unanticipated money output are
and output variation. cointegrated.

Adusei, et al. (2013) Financial Ghana Financial

development and development
economic growth undermines economic
growth.
Ehigiamusoe, (2013). The link between Nigeria. The link between
money market and money market and
economic growth. real sector of the
economy remain very
weak.
Gatawa, et al. (2017). Impact of money Nigeria. Broad money supply
supply and inflation and interest rate were
on economic growth. negatively related to
economic growth.

3. Estimation Techniques

This study is built on the ARDL – bounds test approach to cointegration. The ARDL
approach has been designated for many outstanding benefits. The ARDL technique utilises a
single reduced form of equation to examine the cointegration of the variables as opposed to the
conventional Johansen test that employs a system of equation. Another benefit, it is robust in
small sample (Odhiambo, 2009a, Solarin and Shahbaz, 2013). Whereas, other approaches to
cointegration have a restrictive assumption concerning the other of integration (Pesaran et al.,
2001: 290; Solarin and Shahbaz, 2013). Another advantage of using the ARDL approach to
cointegration is that it does not require the underlying variables to be integrated of similar order,
for example, integrated of order zero I(O), integration of order one I(1) or fractionally, for it to
be applicable. It also provides unbiased estimates of the long- run model, even in cases where
some variables are endogenous (Odhiambo, 2009a). Lastly, it does not rely on the properties of
unit root dataset. Given these advantages, the study employed the ARDL bound testing approach
to cointegration. To ascertain the long run relationship (i.e cointegration), the null hypothesis is
tested against its counterparts (i.e alternative hypothesis of cointegration). The computed F-
statistic is compared to the critical values provided by Pesaran et al. (2001). When the F-
statistics is greater than the Critical value (see Pesaran, 2001:230), we reject the null hypothesis
of no cointegration. On the other hand, when the F-statistics is less than critical value lower
bound, we conclude there is no cointegration. However, when the F-statistics value is in between
the upper and lower bound, the results are inconclusive.

Variables

The dependent variable is Gross Domestic Product (GDP) per capita at constant 2010 is
used as an indicator for economic growth. Predictors variables are money supply (M3); Interest
rate (INT) and Inflation rate (INF). Variable descriptive is given in the subsequent Table 2.

Table 2: Variable Definition

Variable Description
M3 Broad Money supply
GDP Gross Domestic Product per capita
INT Interest rate
INF Inflation rate
 3.1 Cointegration

Following Odhiambo (2008) and Narayan and Smyth (2008), the ARDL-bounds specification for
Model 1 are given Equation 1-4.

ARDL Specification for Model 1 (GDP, M3, INT and INF)

Where is a constant, and are regression coefficients, and are

white noise error terms

3.2 Data Source

The study used time- series data from 1980 to 2016 to investigate the causal relationship between
money supply and economic growth in South Africa. The data was obtained from the South
African Reserve Bank (SARB) and World Bank Development Indicators. Data analysis was
done using Eviews 9.0.

4. Empirical Analysis

4.1 Unit root tests

First step we undertaken in the study was to check whether the variables have unit root or
not. This was examined using the Augmented Dickey Fuller, Phillips and Perron and Dickey
Fuller Generalised Least Squares unit root tests for the four variables. The results are illustrated
in Table 3.

Table 3: Unit root tests

Levels First difference
Variable ADF PP DF-GLS ADF PP DF-GLS
LGDP -0.0354 -0.2472 -0.7289 -4.2473* -4.2215** -4.3510*
LMS -1.5298 -0.5712 -1.9282 -3.3558*** -3.7155*** -3.2716***
INT -2.7487 -2.7566 -2.8259 -6.8979* -7.0838* -5.9870*
INF -1.1016 -2.8051 -2.8183 -4.9768* -9.1120* -3.2556**
*,**,***represent 1%,5% & 10% significance levels, respectively
Source: Authors’ computation

The above results depicts that we cannot reject the null hypothesis of non-stationary ((I(1)) at
levels for all the variables. Therefore, the variables were differenced once to be stationary (I(0))
and that resulted to the null hypothesis to be rejected (i.e no stationary). In overall the variable
are stationary in first difference. The results confirm the aptness of the ARDL-bounds test for
cointegration and granger-causality analysis.

4.2 ARDL-Bound Test Approach to Cointegration

Having established that the variables are stationary, the next step is to examine the long run
relationship between economic growth, money supply, interest rates and inflation. But before
determining whether the variables are integrated, it is necessary to determine the optimal lag
length. The Akaike information criterion is employed to find the optimal lag length and the
results are illustrated in Table 4. The optimal lag length p*=3 is chosen (see Table 4).
Table 4: Selection order criteria
Lag LogL LR FPE AIC SC HQ
0 -79.75927 NA 0.001621 4.927016 5.106588 4.988255
1 110.2776 324.1806 5.56e-08 -5.310449 -4.412590* -5.004253
2 132.3945 32.52478 4.27e-08 -5.670264 -4.054117 -5.119111
3 156.0967 29.27925* 3.03e-08* -6.12337* -3.788904 -5.327229*
Note: Authors’ calculations

The ARDL bounds tests was employed to examine the existence of a long run
relationship among the variables and the results are illustrated in Table 5. The Table 5 below
depicts the evidence of the existence of the long run relationship (i.e cointegration) between
money supply and economic growth. The F-statistics results of the function of the impact of
money supply on economic growth shows cointegration (i.e F-statistics of 20.77 falls above the
upper bound of critical value of 6.36 at 1 percent level of significance). We then infer that there
is a long run relationship between money supply and economic growth in South Africa.

Table 5: Bound F-test for Cointegration

Predictor variable Function F-Statistic Cointegration Results
GDP F(GDP|M3,INT,INF) 20.19*** Cointegrated
M3 F(M3|GDP,INT,INF) 5.79** Cointegrated

INT F(INT|GDP,M3,INF) 7.33*** Cointegrated

INF F(INF|GDP,M3,INF) 6.45*** Cointegrated
Asymptotic Critical value
Pesaran et al. 1% 5% 10%
(2001:300) critical I(0) I(1) I(0) I(1) I(0) I(1)
values, Table: CI(iii) 5.15 6.36 3.79 4.85 3.17 4.14
Case(III)
Note: *, ** and *** denote stationary at 10%, 5% and 1%significance levels respectively.
 Long –Run Coefficients

Table 6: Long run results

Dependent Variable = LGDP
Long Term Results
Regressor Coefficients Standard Error T-statistics
Constant 1.87 3.8618 0.4850
LMS 0.58* 0.3978 1.4653
INT -0.055 0.1244 -0.4409
INF -0.06** 0.0963 0.5772
R-squared 0.99
Durbin Watson Stat 1.94
Where *,**,***represent 1%,5% & 10% significance levels, respectively
Source: Authors’ calculations

The estimated coefficients suggest that money supply has a statistically significant
positive effect on economic growth, which is in line with theoretical argument that money supply
boosts economic growth. More specifically, the long run elasticity of money supply is 0.58,
which implies that a 1% increase in money supply leads to about 0.58% increase in economic
growth, ceteris paribus. The results coincide with the findings of (see Hussia, et al.(2017);
Chaitip, et al. (2015); Ogunmuyiwa, et al.(2010); Babatude, et al.(2011); Chude, et al.(2016);
Mohammad, et al.(2009); Hameed, et al.(2011); Ihsan, et al. (2013); Zapodeanu, et al. (2010);
Maitra, (2011); Aslam, (2016)).

Short-Run Coefficients

Table 7 Short-run results

Regressor Coefficient Standard error T-statistics
LMS 0.24* 0.0490 4.9118
INF 0.01 0.0005 3.1471
INT -0.001 0.0005 -2.2927
ECMt-1 -0.24* 0.0023 -10.7665
R2 0.78
D.W test 1.94
* ,**,*** represent 1%,5% & 10% significance levels, respectively
Source: Authors’ calculation

The short run results are illustrated in Table 7. The results suggest that money supply has
a positive and significant impact on economic growth. The results further suggested that inflation
has a positive effect on economic growth but it is not significant at 5% level of significance.
Lastly, interest rates have a negative but insignificant impact on economic growth in the short
run.

Based on the results illustrated in Table 7, the estimated coefficient of the ECMt-1 is -0.24. Since
the error correction term is negative and significant, this implies that the results support the
existence of a long run between the variables. The results indicate that departure from long-term
growth path due to a certain shock is adjusted by 24% each year.

Table 8 Short-run diagnostics

Short run diagnostics
Test F-statistics P-value
Normality 1.1389 0.5658
Heteroskedasticity 0.8457 0.5601
Serial correlation 0.2452 0.7844
Source: Authors’ calculation

The diagnostic tests results are illustrated in Table 8. It was validated that the error terms
of the short run models are free of heteroscedasticity, have no serial correlation and are normally
distributed. It was also discovered that the Durbin Watson statistics is greater than the R2, which
implies that the short run models are not spurious.

The stability of the long run parameters were tested using the cumulative sum of
recursive residuals (CUSUM) and CUSUM of recursive squares (CUSUMQ). The results are
presented in Figures 4.1 and 4.2 below. The results fail to reject the null hypothesis at 5 percent
level of significance because the plots of the tests fall within the critical limits. Therefore, it can
be realised that our selected ARDL model is stable.

Figure 4.1 CUSUM

16

12

-4

-8

-12

-16
90 92 94 96 98 00 02 04 06 08 10 12 14 16

CUSUM 5% Significance

Figure 4.2 CUSUMQ Test

1.4

1.2

1.0

0.8

0.6

0.4

0.2

0.0

-0.2

-0.4
90 92 94 96 98 00 02 04 06 08 10 12 14 16

CUSUM of Squares 5% Significance

 5. Conclusion
This paper has examined the dynamic impact of money supply (M3) on economic growth
(GDP per capita) in South Africa using time-series data from 1980 to 2016. The study has
employed the recently developed Autoregressive Distributed Lag (ARDL) modeling approach to
estimate both the short and long run elasticities of the selected macroeconomics variables (i.e.
Broad money supply (M3); Interest rate (INT; Inflation rate (INF) and Gross Domestic Product
(GDP) per capita). The study results reveal that there is statistically significant positive
relationship between money supply and economic growth both in short run and long run. These
results shown by this study are proven by many other studies.

These results have a paramount importance in policy implication in South Africa. The authors of
the paper came up with recommendations that would be of great importance in the monetary
policy makers. The government of South Africa should maintain consistency and follow “the
Taylor6 rule” to allow money supply to increase at a steady rate keeping pace with the economic
growth. In respect to such rule will help South Africa Reserve Bank to avoid the inefficiencies
that caused by execution of discretionary policy. In addition to that, the government has to
promote friendly and open agreement to attract short term and long term investment that will be
quick to be converted into cash. In that respect the crises of unemployment and poverty would be
alleviated in South Africa. Since this study shows very clear that money supply is a good vehicle
to convey the economy of South African into the right direction, the government (monetary
policy makers) should implement.

One limitation of this paper is that it has relied on data from the World Bank (for GDP per
capita, INT, and INF) and South African Reserve Bank (for M3). Thus, the validity of the
findings and conclusions is limited to the extent to which these data are plausible. We would,
therefore, recommend a follow-up study using a dataset gathered by a different but equally
reliable institution. In addition, our study has focused on South Africa one of the African
country. It would, therefore, be advisable for future researchers to consider using our
methodology to study other African countries. Notwithstanding these limitations, the paper
makes a significant contribution to the monetary policy makers.

6
Taylor rule is a reduced form approximation of the responsiveness of the nominal interest rate, as set by central
bank, to changes in inflation, output, or other economic condition.
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