The study examines the antecedence of inflation, most especially the effect of money supply growth, interest rate and real depreciation of the cedi on inflation in Ghana using annual time series data from 1990 to 2016. An Autoregressive Distributed Lag model was adopted as the estimation technique to examine the long-run and short-run dynamics among the variables used. In the long run, the regression estimates indicated that there is an insignificant positive effect between money supply growth and inflation. However, interest rate in the long run was observed to have a positive significant effect on inflation in Ghana. Real depreciation of the cedi was also seen to have a negative insignificant effect on inflation. The short run results indicated that money supply growth had a positive insignificant effect on inflation; interest rate and real depreciation of the cedi were equally observed to have a positive significant effect on inflation in Ghana. From the results obtained money supply is not an integral part in the fight against inflation in Ghana. This confirms why the Bank of Ghana has shifted for monetary targeting to inflation targeting monetary policy. Therefore, to reduce inflation in the economy, immediate measures need to be adopted by the Central Bank to strengthen the effectiveness of inflation targeting as a monetary policy. A recommendation is made that the Bank of Ghana should continue to use interest rate as the major instrument in the conduct of monetary policy in Ghana. It is also recommended that measures should be implemented to reduce the depreciation of the cedi, through the reduction of budget deficit financing and reduction in external borrowing.

Ghana formally implemented inflation targeting in 2007 making it one of the first group of emerging market economies and as at the time one of the first low income countries to do so. A 5% inflation rate was set as the medium targeted by the Bank of Ghana. This objective was however affected by negative shocks which made it difficult to achieve the target. Such problems are common in the inflation reduction phase of inflation targeting countries and do not necessary imply policy failure. It however means that there is the need for flexibility in the implementation of inflation targeting. Challenges in the implementation of inflation targeting policies are expected in the economy since it is vulnerable to shocks and has a history of high and variable inflation. Inflation rates came down significantly to as low as 10.7 percent in 2010, 8.7 percent in 2011 and 9.2 percent 2012. It has however returned to double digits, thus, 11.6, 15.4, 17.1 and 17.5 percent as at the end of 2013, 2014, 2014, 2015 and 2016 respectively.

In several instances, monetary policy authorities have reacted vigorously to short-run deviations from targets, in an attempt to maintain credibility. This had a destabilizing impact on the economy. Attempting to hit inflation targets for every year is not desirable and might not be feasible. The challenge should rather be to maintain the credibility of the ultimate target, in the face of variations in the path of inflation. This can be done by not just focusing on annual inflation targets but also being mindful of short-run trade-offs against output and employment (Ekholm, 2010).

Background to the Study
Inflation is a key macroeconomic variable that exerts important influence on macroeconomic stability and is a focal point of macroeconomic policy aimed at achieving sustainable rates of economic growth and development in many countries. Inflation is defined as a persistent increased in the general price level of goods and services in an economy over time. In an inflationary economy, it is difficult for money to act as a medium of exchange and store of value, with adverse effect on output, employment and real income. There is, however, no consensus both in theoretical and empirical literature regarding the factors that drive the inflationary process of many economies, especially in the developing world. While in the monetarist theory aggregate excess demand resulting from excess supply of money is regarded as the only cause of inflation, the structurelist theory accredits inflation to the composition of demand for products and services accompanied by inflexibilities in the productive structure (Fisher & Mayer, 1980).

One of the key culprits of money growth, especially in the developing world, is the monetization of deficits. The monetization of deficits leads to increases in the monetary base in an economy, which implies increases in the money supply, which in turn stimulate aggregate demand and expectations of higher inflation, pushing the authorities to accommodate the resulting price increases.

Friedman (1963) arguing that, high rate of inflation in any economy is due to monetary expansion, some researchers and policy makers argued that government budget deficits are also inflationary. These arguments (Sergent & Wallace, 1981; Leeper &Walker 2012) stem from the method by which government finance their deficits. That is, either by borrowing from domestic or foreign sources or by printing money. This is because, deficits financed by monetization would directly expand the money supply whiles borrowing (particularly from domestic sources) tend to crowd out investment of the private sector and cut down economic growth and aggregate supply, which also has inflationary effect on the economy. Historically, high inflationary economies, especially those in the developing world, also tend to have wide fiscal deficits; suggesting a line between fiscal deficits and inflation.

The Ghanaian economy for more than centuries has experienced high and continuous inflation and a lot of policies and programs like the Economic Recovery Program (1983), the Structural Adjustment Program (1986) that was aimed at solving it proved to be futile. Sowa and Kwakye (1993), Atta-Mensah and Bawumia (2003), Ocran (2007), Adu and Marbuah (2011) among other empirical studies on the causes of inflationary process in the Ghanaian economy have arguably pointed out that, the high and persistent increases in the price of goods and services since the late 1970s has been “nurtured” by monetization of the fiscal deficits, monetary expansion, depreciation of the Ghanaian currency, cyclical food deficits among others.

After Ghana gained independence in 1957, the country encountered relative price stability as the inflation rate floated to a single digit. However, the 1970s and beginning of 1980, saw very high inflationary episode been recorded. The yearly inflation rate recorded, assuaged 100% on four occasions between July 1977 and March 1983. The 1970s in particular was characterized by an increased trend in inflation. Inflation levels remained generally high from 1972 with rates ranging between 10% in 1972 and 123% in 1983, with growth in money supply being 41% and 40% respectively in both years; while the figures for fiscal deficits in that period were 5.7% in 1972 and 2.7% in 1983. The surges in inflation during this period were (1972-1983) could be as a result of the excess growth in money supply due to the monetization of the fiscal deficits. The inflation rate then came down in 1984 to 39% while growth in money supply was 53% and a deficit-GDP ratio of 1.8%. After moderating somewhat during the latter parts of the 1980s; government expenditure goes up in 1992 which was an election year contributed massively to inflation rates surging from 10.1% in 1992 to 24.81% in 1993 and 59.9% by the end of 1995.

In recent times, the inflation rate has been of relatively low when compared with the 1970s and 1980s. In 2000s, the rate has been between 11% and 34% with 2001 and 2011 having the highest and the lowest figures of 32.9% and 8.7% respectively. During this same period fiscal deficit as a percentage of GDP was 7.7% (2001) and 4.2% (2011) while growth in money supply was 56.53% for 2001 and 34.04% for 2011.

Statement of the Problem
The significance of stable prices in achieving macroeconomic stability and providing the congenial environment for attaining sustainable growth in employment and output cannot be overemphasized. As such ensuring price stability in the form of low inflation, so as to anchor governments objectives of attaining higher rates of employment and economic growth remains the focal point and the cornerstone of Bank of Ghana’s monetary policy. For the past three decades, Ghana has succeeded in lowering inflation rates from historically high levels to a single digit, of 8.80 percent in January 2013 (Ghana statistical Service, Quarterly Statistical Bulleting). However, over the four (4) years, the country seems to appear vanquished in the battle against inflation as the general price level has steadily edged up to 13.3 percent in January, 2017. The economy is showing signs of deterioration and the stability of the macroeconomic environment is being threatened as the cedi is losing its external value against major currencies (i.e. depreciating by 6.2 percent against US dollars), with public debt to GDP ratio reaching 74 percent all in 2016 (Ghana Statistic Service report 2016). Furthermore, whereas, ardent monetary growth in recent years (i.e. dropping from 20.4 percent in 2013 to 3.6 percent in 2016), the country continues to experience increasing fiscal deficit and current account deficits (reaching 9.0 percent and 7.8 percent in 2016 respectively) with detrimental effects on the price stability, economic activities and economic growth in general. Whereas government is consolidating its fiscal stance by cutting down taxes’ on some goods and reducing fuel prices and utility subsidies in order to stabilize the price level and economy as a whole, the question remains whether we can rely on fiscal prudence alone to solve the inflationary pressures in the economy.

Again, how is price level influenced by expansion in aggregate money supply? Is there causal link between money growth and inflation rate in Ghana? Does interest rate and exchange rate affect inflation in Ghana? Finding empirical answers to these questions is what this dissertation set out to achieve. This study differs from existing studies by looking at the extent to which both fiscal and monetary policy interacts to influence the price level in Ghana.

As Ghana continues to combat inflation through the framework of inflation targeting and also attaining its objective in meeting the requirement of joining the West Africa Monetary Zone (i.e. Single-digit inflation), understanding of the forces that actually explain the antecedence of inflation cannot be overstressed.

This research therefore explores the relationship between money growth, interest rate, exchange rate and inflation in Ghana. Specifically, it aimed at finding a possible two-way relationship between money supply growth and inflation in Ghana, the effect of interest rate and exchange rate on inflation in Ghana.

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Item Type: Ghanaian Topic  |  Size: 60 pages  |  Chapters: 1-5
Format: MS Word  |  Delivery: Within 30Mins.


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