Determination of real interest rate in Uganda 1986-2016

Abstract

This study examined the determinants of real interest rates in Uganda from 1986 to 2016, using an ECM model after establishing co-integration. The findings revealed that GDP growth rate, inflation rate, and money supply significantly influence real interest rates, though to varying degrees. A unit increase in GDP growth rate raises real interest rates by 0.899 units, while a unit increase in inflation rate reduces real interest rates by 0.241 units. Money supply (M2) showed the largest positive effect, with a unit increase raising real interest rates by 1.64 units, contrary to traditional theory but aligning with the notion that limited money supply raises interest rates. The study found positive relationships between real interest rates, GDP growth, and money supply, while inflation had an inverse relationship. The study recommends that the Ugandan government, through institutions like the Bank of Uganda, implement policies to stabilize macroeconomic variables. Emphasis on inflation control through sound macroeconomic policies is crucial, as lower inflation promotes investment by maintaining high real interest rates. High real interest rates increase demand for securities, contributing to GDP growth and economic progress toward middle-income status. Further recommendations include expediting economic growth policies aligned with Vision 2040, such as industrialization, agricultural modernization, and infrastructural development, to attract investment and enhance output. Addressing structural issues contributing to inflation, rather than solely monetary factors, is essential for stabilizing real interest rates, boosting investment, and fostering aggregate demand growth.