Abstract

After decades of failed developmental efforts, many economies around the world employed the McKinnon-Shaw liberalization thesis to propel the development of their financial systems. Whiles some of these economies had success stories, others had frustrating outcomes. This study examines the financial liberalisation and financial development dynamics considering inflationary effects, in SSA spanning 2000 to 2019. We conducted preliminary tests to ascertain the suitability of the data for the study and then estimated the PVAR model. Impulse response functions and forecast error variance decompositions were obtained from the residuals of the model estimates. The study established a weak, long-run bidirectional relationship between liberalization and financial development, with liberalization accounting for about 0.09% of financial development, while financial development explains about 0.06% of liberalization shocks on average. It takes 3 to 5 years for the impact to manifest after policy implementation. The study further revealed a positive short-run bidirectional relationship between inflation and liberalization, and an inverse short-run bidirectional relationship between inflation and financial development. While inflation explains about 0.87 and 1.79% of liberalization and financial development shocks respectively, liberalization and financial developments respectively explain about 2.62 and 7.41% of inflation shocks on average. It takes 1 to 2 years for the impulse to manifest after policy implementation. We recommend that for financial liberalization policies to succeed, stable inflationary regime and the necessary preconditions for liberalization policies should be in place prior to the implementation of liberalization policies. 

Key words: Liberalization, financial development, endogeneity, exogeneity, stochastic trend, impulse response functions (irf), and forecast error variance decomposition (fevd).