The relationship between financial innovation and demand for money: The Turkish case

The restructuring process that started in the world economies with the globalization process in the 1970s continued and will continue until the present day by accelerating with the developments in financial liberalization applications, information and communication technology in the 1980s. These developments have brought many uncertainties and risks with increasing competition. Therefore, the formation of financial innovations was inevitable. In this study, vector error correction model (VECM) for Turkey has been put forward in the relationship between financial innovation and demand for money and its impact on the demand for money has been investigated. Estimations were made between 2003: 01 and 2019: 03 using monthly data. Primarily, a financial innovation index in line with the characteristics of financial innovations and the different components of it in Turkey (yenind) is formed and then developed and used as predictive model. According to the VECM results, the response of money demand against the shocks of income, interest rate, exchange rate and financial innovation variables is in line with our theoretical expectations although the magnitude of the responses is not at the desired level. The causality relationship between financial innovations and money demand also works in one direction from financial innovations to money demand in line with our theoretical expectations. As a result of the study, financial innovations reduced the demand for money; however, the contribution of financial innovations to changes in money demand remained relatively low in the short term.