The effects of interest rate on economic growth: Further insights from the Gambia

Abstract

The main objective of this paper is to examine the effects of interest rate on economic growth in Gambia over the period 1993 to 2017. The Vector E rror Correction Model (VECM) is used to check the relationships between the dependent variable (Gross Domestic Product) and independent variables (Real Effective Exchange Rate and Real Interest Rate), both in the short-run and long-run. Post estimation tests, including Lagrange Multiplier test for residual autocorrelation were also conducted for autocorrelation, as well as Jarque Bera to test for stability and to check whether residuals are normally distributed. The empirical evidence indicates that there is no short-run association between the growth of the Gambian economy and interest rate but that there is a long run connection that runs from real interest rate and real exchange rate to GDP. Based on these findings, the paper recommends for the government through the Ministry of Finance and Economic Affairs to prudently manage the Gambia’s budget by avoiding unnecessary expenditures that could lead to budget deficits.These budget deficits are key drivers that cause interest rates to rise, which in turn are inimical to economic growth. Key words: Gross domestic product, real interest rate, real exchange rate, Vector Error Correction Model (VECM).

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