Remittances and Financial Development in Kenya: An Autoregressive Distributed Lag Approach

Abstract

This study estimates an Autoregressive Distributed Lag (ARDL) econometric model between 1970 to 2018 to test the long-run effect of remittances on financial development in Kenya. It also interacts remittances with monetary policy and human capital to test their complementarity in facilitating financial development. The long-run model finds that remittances hurt financial development contradicting the theoretical view. A possible explanation is the substitutability hypothesis which states that remittances replace the demand for financial products. The long-run model’s results find that monetary policy complements remittances while human capital harms the complementarity role of remittances. More studies are required to isolate the cause of the negative externality of human capital in facilitating remittances to boost financial development. Surprisingly, openness and economic growth used as control variables have negative effects on financial development, which also need further study. The long-run equilibrium model adjusts at a speed of 51.8 percent to correct short-term disequilibrium after every two years. The study recommends that policymakers in Kenya should be cautious about the negative side effects of remittances on financial development. This study recommends that policymakers identify prudent monetary, exchange rate, trade, and fiscal policies to curb the side effects of remittances in the economy and broader development planning.