Justifying the Adoption and Relevance of Inflation Targeting Framework: A Time-Varying Evidence from Ghana

TL;DR

This paper evaluates Ghana's inflation targeting adoption in 2002, analyzing the stability of the money supply-inflation relationship over decades, and finds evidence supporting IT's role in stabilizing inflation despite changing monetary dynamics.

Contribution

It provides empirical evidence on the evolving relationship between money supply and inflation in Ghana, supporting the effectiveness of inflation targeting since its adoption.

Findings

Unstable link between inflation and monetary growth in Ghana.

Negative inflation elasticity to monetary growth during 2001-2004.

Prolonged period of single-digit inflation (2010-2012) supports IT effectiveness.

Abstract

This paper scrutinizes the rationale for the adoption of inflation targeting (IT) by Bank of Ghana in 2002. In this case, we determine the stability or otherwise of the relationship between money supply and inflation in Ghana over the period 1970M1-2016M3 using battery of econometric methods. The empirical results show an unstable link between inflation and monetary growth in Ghana, while the final state coefficient of inflation elasticity to money growth is positive but statistically insignificant. We find that inflation elasticity to monetary growth has continued to decline since the 1970s, showing a waning impact of money growth on inflation in Ghana. Notably, there is also evidence of negative inflation elasticity to monetary growth between 2001 and 2004, lending support to the adoption of IT framework in Ghana in 2002. We emphasized that the unprecedented 31-months of single-digit inflation (June 2010-December 2012), despite the observed inflationary shocks in 2010 and 2012, reinforces the immense contribution of the IT framework in anchoring inflation expectations, with better inflation outcomes and inflation variability in Ghana. The paper therefore recommends the continuous pursuance and strengthening of the IT framework in Ghana, as it embodies a more eclectic approach to policy formulation and implementation.