Monetary policy and trade openness in Ghana

Anthony Chiaraah

doi:10.4314/gjds.v16i2.12

Abstract

Monetary policy is one of the key drivers of economic growth in most economies and through its impact on economic variables. The objective of this study is to analyse the effectiveness of monetary policy in Ghana taking into account the role of trade openness and trade policy in influencing the effectiveness of monetary policy. The study employed the co-integration approach with quarterly data from 2002 to 2016 to assess the relationship between trade openness and effectiveness of monetary policy in affecting inflation and output. The empirical result revealed that as the degree of trade openness increases, monetary policy become less effective in reducing the rate of inflation and causes domestic output to decline in the long-term. Though the results of the study confirmed the theoretical relationship between trade openness and inflation and output, the results indicated that when monetary policy is taken into account, negative effect of trade openness on inflation is reduced. The ability of trade openness to reduce inflation level in Ghana is hindered by increases in the monetary policy rate. Thus, the results implies that trade openness hinders monetary policy’s ability to curtail inflation in Ghana whilst it is able to effectively cause output to decline. Keywords: Monetary Policy, Inflation, Output, Trade Openness, Co-integration

Highlights

Monetary policy is one of the most important and key drivers of economic growth in most nations
Results obtained by Karras (1999, 2001) for example indicated that an expansionary monetary policy in an open economy causes inflation to rise, results obtained in this study indicate that for a developing economy that is import dependent, contractionary monetary policy becomes ineffective in reducing inflation rate
Trade openness is expected to diminish the ability of changes in monetary policy rate to influence the level of economic activity

Summary

INTRODUCTION

Monetary policy is one of the most important and key drivers of economic growth in most nations. The Ghanaian economy presents a different economic situation (in terms of policy instrument and its composition of trade over the years) to what have been examined in the literature, the need to examine the extent to which openness to trade affects the effectiveness of monetary policy in Ghana. The Marshall Lerner Condition shows the conditions under which a change in the exchange rate of a country’s currency leads to an improvement or worsening of a country’s balance of payments This states that, for a currency devaluation to lead to an improvement (for example, reduction in deficit) in the current account, the sum of price elasticity of exports and imports (in absolute value) must be greater than one. Allowing capital to flow freely with no fixed currency exchange rate agreement

Autonomous monetary policy

RESULTS AND DISCUSSION

Conclusions and Policy Implications