Fiscal deficit, money growth and inflation dynamics in Ghana

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The issue of inflation has attracted a great deal of attention over the past two decades, as reflected in substantial academic literature. The objective of the study was to investigate the causal relationship between fiscal deficits, money growth and inflation, having controlled for macroeconomic variables such as interest rate, exchange rate and real GDP in the Ghanaian economy for the period 1960-2012 and to test whether the Sargent Wallace Hypothesis holds for the Ghanaian economy. The time series properties of the underlyin g series were examined using the Argumented Dickey Fuller and the Philip Perron unit root tests and the result reveals that the interaction between fiscal deficit and money supply, fiscal deficit, money supply, were all stationary at the levels, while other incorporated variables in the empirical analysis- real income and the nominal exchange rate -were stationary at first difference. Using the autoregressive distributive lag model the long and short run models were estimated, and the Granger Causality test was employed to test for causality among the variables. The results suggest a positive relationship between fiscal deficits and inflation in the Ghanaian economy occurs only in the short run; however the money supply shows a consistent positive relationship with inflation, both in the short and long run. This supports the position that in the long run, inflation is mainly driven by monetary expansion. The Granger causality test supported a unidirectional causality from fiscal deficit to inflation and money supply; and a bi-directional causality existing between money supply and inflation. The results indicated that the best approach to understand the causal relationship between fiscal deficit, money supply and inflation in the Ghanaian economy in the long run is given by the SW-H. The study suggested policies which aimed at properly formulating and implementing good monetary and fiscal policies.
A thesis submitted to the Department of Economics, in partial fulfillment of the requirement for the award of Master of Philosophy degree in Economics,