Does Monetary Policy Action Have Significant Impact on the Real Economy? A Critical Look at the Aggregate Demand Function for Ghana

Abstract

This paper examines the impact of monetary policy on real economic activities using a modified open-economy New Keynesian aggregate demand function for Ghana over the period 2000Q1-2016Q4. Our analysis shows that all the determinants of aggregate demand have the expected theoretical signs. We observed that tighter monetary policy dampens economic activities in Ghana, as the elasticity of domestic output gap to changes in real monetary condition index – which is a combination of real exchange rate and interest rate gaps - were all negative and significant. The results also show that lag and lead domestic output gap, foreign output gap and structural fiscal gap have positive impact on current output gap. In particular, the weight of real exchange rate in the output gap equation appears to outweigh that of real interest rate and lagged output gap in the case of Ghana. This accentuates the relevance of real exchange rate in Ghana's monetary policy transmission mechanism.