The effects of transitory and permanent inflation uncertainty on investment in Ghana

Abstract

We examined the effect of inflation uncertainty on domestic investment in Ghana using annual data for the period from 1963 to 2016. We decomposed inflation uncertainty into its transitory and permanent components in order to understand what component drives overall inflation uncertainty on investment. We found that, in the short run, while transitory inflation uncertainty affects investment in a differential manner, permanent inflation uncertainty affects investment negatively and insignificantly. The differential short-run effects of transitory inflation uncertainty on investment pass on to the long run as positive and significant effects. The negative short-run effect of permanent inflation uncertainty passes on to the long run insignificantly. Additionally, we found that total inflation uncertainty has differential short-run effects on investment, which passes on as negative and insignificant long-run effects. These results suggest that transitory inflation uncertainty tends to drive the differential short-run effects, while permanent inflation uncertainty drives the negative long-run effects. By decomposing uncertainty into transitory and permanent components, the overall dynamics of inflation uncertainty on domestic investment becomes clear. These findings are broadly consistent with the theoretical studies arguing that uncertainty may inhibit domestic investment. The findings suggest that counter inflationary policies should be more focused on moderating the volatility of inflation.