Is the interest rate setting behaviour of the Bank of Ghana constrained by high debt levels?

Abstract

AbstractWhile assertions of debt constraints on monetary policy have been documented in the literature, empirical investigation into this phenomenon remains egregiously limited, with the only study using the Generalized Method of Moments that fails to provide confidence intervals for the threshold estimate. We examine whether or not high debt levels constrain the interest rate setting behaviour of the Bank of Ghana, with the aid of sample splitting and a threshold estimation technique that overcomes the weaknesses of previous studies. We find that monetary policy response to inflation gap in the high debt regime (above the debt to gross domestic product [GDP] threshold of 35.1%) is woefully disproportionate, a key indication of debt constraint and inflation accommodation by a central bank that is supposed to be targeting inflation. Important policy recommendations are proffered.