13 appropriateness of functional form. (The basic assumptions relating to the OLS error process were amply supported by various test statistics.) The result for the RSTD variable in both equations suggests that individual financial asset-holding behavior strongly depends on the rate of return on bank deposits. For the post- reform period (1978-87), a one percent increase in RSTD seems to have been associated with a 0.8 percent decline in real cash holdings and a 4.2 percent increase in real RSTD. The equation for STD showed a significant wealth effect operating upon financial savings behavior: a one-percent change in GDP was associated with a 1.5 percent change in STD. This effect on demand for Ml was also statistically significant. but much smaller (0.5 percent). In sum, portfolio shifts (both from cash balances and other assets) triggered by interest rate policy were behind the surge in bank deposits (and hence the degree of financial intermediation), while the weaith effect generated by liberalization-led income growth seems to have played an important but secondary role.

Was the growth of financial savings reflected in an increase in the level of total domestic savings? According to the McKinnon-Shaw thesis, a positive link between interest rates and financial savings also implies a positive link between the former and total domestic savings (investment), for at least two reasons. First, according to McKinnon's "complementarity hypothesis" in a developing country context, a decision to accumulate financial savings is coterminous with a decision to acquire physical capital. Second, given limited portfolio choices, the savings process in these countries tends to be highly "money intensive" (McKinnon, 1976). A contrary view is expressed by the neo-structuralists, who argue that while raising the rate of return on bank deposits is likely to induce a portfolio shift in favor of that asset, such a response need not reflect more savings but simply a decline in other assets (Taylor, 1988).

Jayawardena et al. (1987) interpret the Sri Lankan experience as supportive of the neo-structuralist position. Despite the impressive growth of bank deposits, there was "little evidence of any-significant mobilization of domestic savings" (p. 27). But the data reported in Table 8 suggest that this observation, based on an analysis of data on total domestic savings, is misleading. During this period, public sector savings performance did not show any improvement, indicating the country's heavy dependence on foreign aid. t)onetheless, the behavior of private savings was an impressive improvement over the pre-reform period. For- instance. the average propensity to save (the private savings to private ineome ratio, or PRS/YPR) increased from 14.4 ptr-ent in the 197Q-76 p-jri'd t( 20.2 percent in the 1977-84 period. Ec('nmetri.w -rk (Athukorala and Jayasuriya, 1989) lends supj'('tt **t'** the - j- **ti4'f** intPrest rat'j r;t''rm wa-y laid behind this improvement. The-timato- -ugaest an inteleZt. late elasticitv ''f .98 per_ent and an in Wla i ity omf ('t 1.22 per ent. **t'L** private savings. In sum. whpn the analv-in i- appropriately f'uqewl on private savings behaviol. **thi-** SL i LasnkIan -xl i. i "nf e pr''vides ampl Quplfor the McKinnon-Shaw vipw point ] 13. The evidence on interest elast i i,v f 'an in 1XveP1o!inV 'nt I i@, which come from numerous multi'untrv - studies, i- tar (continued on next page)