Essays on exchange rate behaviour and macroeconomic performance in Ghana
Thesis (PhD)--Stellenbosch University, 2017.
ENGLISH SUMMARY : In the presence of increased globalisation and liberalisation of trade and payment regimes, the role of the exchange rate in macroeconomic adjustments has become even more crucial, particularly for developing economies. In fact, the economic crisis in Ghana between the late ‘70s and early ‘80s is attributed to inappropriate exchange rate policies such as exchange rate controls and overvalued exchange rates, among other factors. Thus, in 1983 the government of Ghana adopted the International Monetary Fund (IMF) and World Bank (WB) sponsored programmes and embarked on exchange rate, trade and payment reforms among others. In particular, the exchange rate reforms were aimed at correcting the misaligned exchange rate and enhancing the competitiveness of the export sector in order to improve trade with the rest of the world. Even though the macroeconomic performance has improved after the reforms, the economy is still confronted with series challenges including persistent trade deficits and inflation, leading to macroeconomic instability. In addition, since the exchange rate was completely liberalised in 1988, it has generally been on a depreciating path. The impact and response of exchange rate movements on the macro-economy has been a subject of interest among economists and policy makers. This thesis contributes to this body of research. Generally, the main aim of this study is to examine the behaviour of the exchange rate and its impact on the macroeconomic performance of Ghana. The specific questions addressed are as follows: a) Is there an association between the trends in the exchange rate in the various exchange rate regimes and key macroeconomic variables? b) What are the macroeconomic variables that determine movements in the long-run equilibrium exchange rate? c) Is the exchange rate moving in tandem with its equilibrium path or is it misaligned? d) What is the relationship between movements in the exchange rate and the trade balance? e) What is the extent of pass-through of exchange rate to consumer prices? f) Is the pass-through symmetric or asymmetric? Various methods, including the descriptive method, the Johansen cointegration and Vector Error Correction techniques and the Autoregressive Distributed Lag (ARDL) approach are employed in analysing the data used in the thesis. The empirical analysis makes use of secondary data from various sources including the World Bank, World Development Indicator, the International Monetary Fund, International Financial Statistics, and the Bank of Ghana. The questions addressed in the study have been organised into four empirical essays. The first essay examines the association between the trends in the exchange rate in the various exchange rate regimes and key macroeconomic variables using the descriptive method. The key lessons of this study are summarised as follows: The flexible exchange rate regime has introduced a series of fluctuations in the exchange rate that was not an issue during the fixed exchange rate period. For a small open economy heavily reliant on imported goods, such fluctuation may affect domestic prices and overall macroeconomic stability. Second, the increase in trade with exports lagging behind imports has resulted in consistent trade deficits, which has implications for economic growth. Thus, in order to ensure macroeconomic stability and growth in a managed float exchange rate system, improvement in export competitiveness and the quality of locally produced goods, and proper management of reserves is vital. The second essay explores the presence and extent of exchange rate misalignment of the Ghana cedi relative to trading partner currencies using the Johansen cointegration approach and error correction models. Results point to significant misalignment of the exchange rate. There are two major episodes of undervaluation and overvaluation. The undervaluation episode was consistent from 1984 until 2007, when the overvaluation episodes occurred mainly due to the redenomination exercise. The implication is that the actual real effective exchange rate has not been moving in line with its equilibrium trajectory or the path dictated by the underlying fundamentals that drive movements in the exchange rate. This suggests that exchange rate policy and management has been very poor over time. The study makes some recommendations. First monetary authorities could adopt the floating exchange rate system where market forces are allowed strictly to determine the equilibrium exchange rate. Second, in pursuing the managed float system of exchange rate, it is imperative that the two extremes of misalignment be reconciled. Going forward, the exchange rate may have to be devalued to bring it closer to the equilibrium. Subsequently, market forces should be allowed to correct the exchange rate back to equilibrium. Thereafter, monetary authorities should, closely monitor the equilibrium in order to engage in timely interventions when deviations are significantly far from the equilibrium. The third essay examines the link between movements in the real effective exchange rate and the trade balance of Ghana using both linear and nonlinear ARDL approach. Both symmetric and asymmetric effects of the exchange rate on the trade balance are explored. The results emanating from this study reveal the relationship between the exchange rate and the trade balance is symmetric model. Accordingly, both depreciation and appreciation episodes of the real effective exchange rate do not result in an improvement in the trade balance. In addition, the relationship between the domestic income and the trade balance is significant and negative, whereas foreign income is insignificant. The findings of this study imply that the real effective exchange rate is important for trade, however it is not sufficient alone to drive the growth needed to improve the trade balance substantially. Hence, complementary policies are necessary in achieving improvement in the trade balance. That is, in order to improve the trade balance position, it is critical that measures be put in place to significantly increase exports and also reduce the import bill. The fourth essay explores the magnitude of Exchange rate Pass-Through (ERPT) to consumer prices in Ghana for the period 1980 to 2015 employing the Johansen Maximum Likelihood approach. There is evidence to suggest a significant asymmetry with respect to direction and size of exchange rate changes. Specifically, ERPT is incomplete but relatively higher in periods of depreciation than in periods of appreciation; that is 53% against 3%. ERPT is also higher during episodes of large changes (about 51%). It is imperative that the monetary authorities critically monitor exchange rate movements to ensure swift policy action to counteract any inflationary pressures from the external sector. In particular, monetary authorities should pay attention to events and arrangements that could result in large depreciation of the exchange rate. The overarching evidence presented in this thesis suggests that the exchange rate influences macroeconomic stability through its impact on inflation. In addition, exchange rates alone will not provide the needed growth in the trade sector and, hence, influence economic growth in Ghana. The findings point to weaknesses in the underlying structure of the economy. Therefore, appropriate complementary policies like trade policy and industrial policy that support the production of high quality goods of international standards are critical. This will deliver results in terms of improvement in trade performance, ensuring macroeconomic stability and position the economy on a consistent growth path.
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