Inflation and interest rate movements in Ghana: trends and possible causal links

Abstract

The relationship between inflation and interest rate has remained controversial in Ghana and this called for the investigation into the trends and causal links between the two variables. Monthly observations from 1995 to 2011 were used for analyses of trends, causality, cointegration and error correction model. The study reveals significant trends of variability over time with the trend of inflation being more volatile relative to interest rate. There is a two-way causal relationship between inflation and nominal interest rate and there exists also a long-run equilibrium relationship between the variables. The results suggest inflation in Ghana in the short-run depends on previous month’s inflation rate and past interest rates, but not on current interest rate. The impulse response shows past inflation rates and nominal interest rates account for macroeconomic instability in the economy. It is recommended long-run policy measures be used to promote macroeconomic stability.