Demand for Money, Structural Break and Money's Role in Monetary Policy in Ghana: An Empirical Evidence

Abstract

We examine the (in)stability of real money demand function and the relevance of money in the contemporary monetary policy framework in Ghana. Both Bai-Perron (2003) structural stability and Quandt-Andrews unknown break tests were applied to ascertain possible structural breaks in Ghana’s money demand function, while impulse responses and variance decomposition techniques based on structural VAR framework were employed to determine the pass through of money demand growth to inflation and exchange rate. Our empirical results showed evidence of an unstable money demand function for Ghana over the sample period (1996Q1 – 2015Q2). In spite of the observed instability, Ghanaian demand for money was found to be positively affected by real income, exchange rate depreciation and financial innovation, but negatively influenced by interest rates (both foreign and domestic) and real dollarization. The study also uncovered that growth in money demand has a strong indirect positive impact on inflation, principally via the exchange rate channel. Our empirical results remit cogent policy proposition that money still contains useful information for future prediction of inflation in Ghana. The empirical findings thus proffer strong support for a continuous monitoring of the monetary aggregates (alongside other real sector and financial information) in order to rein in inflation in Ghana.