Description
The Ghanaian economy has experienced relative stability, improved macroeconomic
performance and resilience over the past few years, following the introduction of a new monetary
policy framework called inflation targeting (IT). The purpose of this paper is to look at IT and its effect
on inflation management in Ghana.
Journal of Financial Economic Policy
Inflation targeting and inflation management in Ghana
Anthony Kyereboah-Coleman
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To cite this document:
Anthony Kyereboah-Coleman, (2012),"Inflation targeting and inflation management in Ghana", J ournal of
Financial Economic Policy, Vol. 4 Iss 1 pp. 25 - 40
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In?ation targeting and in?ation
management in Ghana
Anthony Kyereboah-Coleman
Department of Finance, University of Ghana Business School,
University of Ghana, Accra, Ghana
Abstract
Purpose – The Ghanaian economy has experienced relative stability, improved macroeconomic
performance and resilience over the past few years, following the introduction of a new monetary
policy framework called in?ation targeting (IT). The purpose of this paper is to look at IT and its effect
on in?ation management in Ghana.
Design/methodology/approach – The study employed monthly time series data from1980 to 2009.
Findings – The results gathered in this study demonstrate that IT has had a signi?cant impact on
the reduction of in?ation series in recent years and has reduced the persistence of in?ation series
considerably. It is largely ampli?ed that the implementation of an IT framework in Ghana has been a
success and has contributed to a change in the conduct of monetary policy towards best practice.
Research limitations/implications – The study could have used a lot more macroeconomic
variables.
Practical implications – The paper’s ?ndings are very important for Central Banks that are using
the IT framework, or planning to do so, for ef?ciency and effectiveness.
Originality/value – The paper is the ?rst of its kind for developing countries, especially in Africa
and Ghana for that matter.
Keywords Ghana, Monetary policy, Macroeconomics, In?ation, Open economy macroeconomics,
In?ation targeting
Paper type Research paper
1. Introduction and background
Since the introduction of In?ation Targeting Policy (ITP) in New Zealand in the early
1990s, evidence of it impact on in?ation management led some central banks from
industrialized and transition or emerging economies of the third world to adopt ITP as a
preferred framework for monetary policy. Due in part to its perceived ef?cacy, ITP has
replaced monetary targeting framework, exchange rate and prices as the most ef?cient
framework for managing commodity prices. Apart from the partial response to
the success story of New Zealand, the overwhelming acceptance of this framework,
according to (Pe´tursson, 2004, p. 1), is credited to the fact that IT combines two aspects
considered important for successful monetary policy, i.e. providing a credible
medium-term anchor for in?ation expectations and at the same time allowing central
banks enough leverage to respond to short-run shocks without endangering the
credibility of the framework.
In broad terms, the ITP framework involves “the public announcement of IT, coupled
with a credible and accountable commitment on the part of government policy
authorities to the achievement of these targets” (Setter?eld, 2006, p. 653). In addition, IT
is usually associated with appropriate changes in the central bank law that enhances
The current issue and full text archive of this journal is available at
www.emeraldinsight.com/1757-6385.htm
JEL classi?cation – C22, E31, E52
In?ation
targeting
in Ghana
25
Journal of Financial Economic Policy
Vol. 4 No. 1, 2012
pp. 25-40
qEmerald Group Publishing Limited
1757-6385
DOI 10.1108/17576381211206460
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the independence of the institution. In practice, while few central banks reach the “ideal”
of being “fully ?edged” IT, many others still focus on ?ghting in?ation to the virtual
exclusion of other goals. ITinvolves several elements including: public announcement of
medium-term numerical target for in?ation; an institutional commitment to price
stability as the primary long run goal of monetary policy and a commitment to achieve
the in?ation goal; an information-inclusive approach in which many variables are used
in making decisions about monetary policy; increased transparency of the monetary
policy process through communication with the public and the markets about objectives
of monetary policymakers and increased accountability of the central bank for attaining
its in?ation goals (Svensson, 2007;Mishkin,2007, pp. 402-3). The preference for IT over
other frameworks is due in part to the fact that the framework provides credible anchor
for monetary policy over the medium-term.
Bank of Ghana (i.e. The Central Bank of Ghana) emphasized in its announcement of
early 2002 indicated the adoption of IT as the framework for the conduct of monetary
policy, marking an end to monetary aggregates targeting regime which had been in use
for over two decades since 1983 with the introduction of the Economic Recovery
Program. The core motive, according to the monetary authorities, for this switch was
to reduce the volatility of in?ation and also to enhance transparency. Accompanying
this announcement was the creation of monetary policy committee, independent of
government and responsible for quarterly formulation and reviewing of monetary
policy, based on medium to long-term targets. In this process, the policy rate (i.e. prime
rate) is used as an instrument for correcting deviations of in?ation from target.
The general assertion on the trajectory of in?ation in Ghana is that the relative
stability of in?ation over the last few years could be attributed to the adoption of IT
and that in spite of the global recession the Ghanaian economy has remained relatively
resilient with in?ation remaining relatively low reaching single digit recently.
Data on in?ation and other macroeconomic series show signi?cant variation over the
two periods (pre- and post-IT); for instance year onyear in?ation, measured bypercentage
change in the consumer price index (CPI), declined from an average of 31.85 per cent
between January 1997 and December 2001 to 16.4 per cent between 2002 and 2008.
Volatility of in?ation also declined signi?cantly with the standard deviation falling from
15.6 to 5.2. In the pre-IT period, the minimum in?ation recorded was about 12.4 per cent
and a maximumof 66.4 per cent compared to 9.5 and 31 per cent in the post-ITperiod. The
question is “has the adoption of IT enhanced the management of in?ation in Ghana?”
Answer to this question is not readily available since no study has been carried out to
examine scienti?cally the issue. This is the thrust of the present study. Thus, the basic
objective is to empirically examine the relationship between IT and in?ation series in
Ghana and also to assess the extent of in?ation persistence, and ?nally to examine the
pass through effect of macroeconomic series to in?ation after the introduction of IT.
The rest of the paper is organized as follows: Section 2 discusses the literature;
Section 3 looks at methodology; Section 4 is devoted to the discussion of empirical
?ndings; and Section 5 concludes the study.
2. Review of literature
2.1 Theoretical literature
2.1.1 Monetary policy regimes. In practice, monetary policy involves modifying the
amount of base currency (M0) in circulation. The distinction between the various types
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of monetary policy lies primarily with the set of instruments and target variables that
are used by the monetary authority to achieve their goals. Table I provides a summary
of monetary policy regimes.
2.1.2 In?ation targeting. Under this policy approach the target is to keep in?ation,
under a particular de?nition such as CPI, within a desired range. The in?ation target is
achieved through periodic adjustments to the Central Bank interest rate target. The
interest rate used is generally the interbank rate at which banks lend to each other
overnight for cash ?ow purposes. The interest rate target is maintained for a speci?c
duration using open market operations. Typically the duration that the interest rate
target is kept constant will vary between months and years and is usually reviewed on a
monthly or quarterly basis by a policy committee. Changes to the interest rate target are
made in response to various market indicators in an attempt to forecast economic trends
and in so doing keep the market on track towards achieving the de?ned in?ation target.
IT framework increases transparency and accountability as the central bank must
publicly divulge its precise target for monetary policy and also successes and failures
are readily apparent to all. The main drawback of IT is that in?ation responds to policy
actions only with a long lag. As a result, the Central Bank cannot easily judge which
policy actions are needed in order to hit the in?ation target and the public cannot easily
determine whether the central bank is living up to its promises. In this situation, IT
central banks may badly miss their targets, losing credibility as a result.
2.1.3 Price level targeting. Price level targeting is similar to IT except that the CPI
growth in one year is offset in subsequent years such that over time the price level on
aggregate does not move. Something similar to price level targeting was tried by
Sweden in the 1930s, and seems to have contributed to the relatively good performance
of the Swedish economy during the Great Depression.
2.1.4 Monetary aggregates. This approach is also sometimes called monetarism.
While most monetary policy framework focuses on a price signal of one form or
another, this approach is focused on monetary quantities.
2.1.5 Fixed exchange rate. This policy is based on maintaining a ?xed exchange rate
with a foreign currency. There are varying degrees of ?xed exchange rates, which can be
ranked in relation to howrigid the ?xed exchange rate is with the anchor nation. Under a
system of ?at ?xed rates, the local government or monetary authority declares a ?xed
exchange rate but does not actively buy or sell currency to maintain the rate. Instead, the
rate is enforced by non-convertibility measures. In this case, there is a black market
exchange rate where the currency trades at its market/unof?cial rate. Under a systemof
?xed-convertibility, currency is bought and sold by the central bank or monetary
authority on a daily basis to achieve the target exchange rate. This target rate may be a
?xed level or a ?xed band within which the exchange rate may ?uctuate until
Monetary policy Target market variable Long term objective
In?ation targeting Interest rate on overnight debt A given rate of change in the CPI
Price level targeting Interest rate on overnight debt A speci?c CPI number
Monetary aggregates The growth in money supply A given rate of change in the CPI
Fixed exchange rate The spot price of the currency The spot price of the currency
Gold standard The spot price of gold Low in?ation as measured by the gold price
Mixed policy Usually interest rates Usually unemployment þ CPI change
Table I.
Monetary policy regimes
In?ation
targeting
in Ghana
27
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the monetary authority intervenes to buy or sell as necessary to maintain the exchange
rate within the band. Hence, the ?xed exchange rate with a ?xed level can be seen as a
special case of the ?xed exchange rate with bands where the bands are set to zero. Under
a system of ?xed exchange rates maintained by a currency board every unit of local
currency must be backed by a unit of foreign currency to correct for the exchange rate.
This ensures that the local monetary base does not in?ate without being backed by hard
currency and eliminates any worries about a run on the local currency by those wishing
to convert the local currency to the anchor currency. These policies often abdicate
monetary policy to the foreign monetary authority or government, as monetary policy in
the pegging nation must align with monetary policy in the anchor nation to maintain the
exchange rate. The degree to which local monetary policy becomes dependent on the
anchor nation depends on factors such as capital mobility, openness, credit channels and
other economic factors.
2.2 Empirical literature
The success of IT in New Zealand and for most other adopters ignited lots of empirical
studies into the effectiveness of IT in reducing in?ation volatility. Several researchers
have attempted to check whether the adoption of IT creates a structural change in an
economy. Two main divergent conclusions are drawn from empirical literature: on one
hand, some economists conclude that the IT makes no statistical difference to the
macroeconomic performance of IT countries (Huh, 1996; Bernanke and Mihov, 1998;
Lane and van den Heuvel, 1998; Bernanke et al., 1999; Honda, 2000; da Silva and
Portugal, 2000). Some of them prove that IT does not cause a structural break in the
in?ation rate path. For instance, Ball and Sheridan (2003, 2005) provide evidence on the
irrelevance of IT.
Other notable authors show paradoxical conclusions (Almeida and Goodhart, 1996;
Batini and Laxton, 1994; Fillion and Le´onard, 1997; Choi et al., 2003; Pe´tursson, 2004;
Mishkin, 2007). They conclude that the ITP reduces in?ation persistence and causes a
structural break in the in?ation dynamic. Mishkin (2007, p. 406) in enumerating the
bene?ts of IT asserts that IT countries seem to have signi?cantly reduce both the rate
of in?ation and in?ation expectations beyond what would is likely to have occurred in
the absence of IT. Condon (2006) suggests that Bank of Korea’s policy of IT seems to
have anchored in?ation expectations more ?rmly than in the previous regime and this
may be responsible for the superior performance of the economy in response to
in?ation shocks. Pe´tursson (2004) compares the average standard deviation of actual
in?ation in the ?ve years before and after the introduction IT and suggests that
adoption of IT contributes to reduced ?uctuations in in?ation. Bernanke et al. (1999),
despite favouring IT, report widespread evidence that IT central banks do not reduce
in?ation at a cost lower than other countries’ central banks in terms of forgone output
(sacri?ce ratio). Bernanke (2003, p. 1) suggests that:
[. . .] central banks that have switched to in?ation targeting have generally been pleased with
the results they have obtained; the strongest evidence on that score is that, thus far at least,
none of the several dozen adopters of in?ation targeting has abandoned this approach.
Johnson (2002) by comparing ?ve IT nations to six non-IT nations, all of them in
industrialized economies, ?nds that the period after the announcement of IT is
associated with a statistically signi?cant reduction in the level of expected in?ation.
JFEP
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Neumann and von Hagen (2002) considered a group of six industrialized IT countries
and three non-IT countries and performed an event study to quantify the response of
in?ation and long run as well as short-run interest rates to supply shocks. They found
that the effect of IT is not signi?cantly different from zero for average in?ation, but it is
for interest rates, meaning a gain in credibility among in?ation targeters. Vegaa and
Winkelried (2005) using the differenced in difference estimator on selected
industrialized and emerging economies ?nd that IT has helped in reducing the level
and volatility of in?ation in the countries that adopted it.
In a comparative study on the persistence of in?ation using ?ve users and seven
non-users of IT, Levin et al. (2004); observed that in?ation was stationary but the
hypothesis of unit root could not be rejected for non ITnations. Levin and Piger (2004) in a
similar empirical study using 12 industrial countries, and allowing for structural breaks
?nds that in?ation, in general, exhibits low persistence. Their results also suggest that
that ITdoes not appear to have a large impact on long-termexpected in?ation for a group
of 11 emerging market economies. Findings of Pe´tursson (2004) again suggest that IT
reduces in?ation persistence but a contrary view is held by Ball and Sheridan (2005).
Dueker and Fisher (2006) provide comparative analysis by matching three IT
countries (New Zealand, Canada and the UK) with three nearby non-IT countries
(Australia, the USA and Germany), and ?nd little evidence that an IT regime performs
better than a non-IT regime. Gonc¸alves and Carvalho (2009), however, show that IT
OECD countries suffer smaller output losses in terms of sacri?ce ratio during the
disin?ationary period than non-targeting counterparts. Angeriz and Arestis (2008)
employing intervention analysis ?nd lower in?ation rates, well-anchored and accurate
in?ation expectations for both targeting and non-targeting countries. In the foregoing
analysis, there is ample evidence in support of the bene?ts associated with IT. Those
countries which adopted IT, managed to reduce in?ation to low levels and to curb
in?ation and interest rate volatility. Anecdotal evidence has also been propounded to
make the IT case. Bernanke (2003, p. 1) suggests that:
[. . .] central banks that have switched to IT have generally been pleased with the results they
have obtained. The strongest evidence on that score is that, thus far at least, none of the
several dozen adopters of in?ation targeting has abandoned this approach.
In spite of the pronounced gains emanating from IT, there is little empirics especially in
Africa and for that matter Ghana. This may be due to the lingering acceptance of the IT
concepts by Central Banks on the African continent. This study, therefore, contributes
enormouslyto the debate byprovingempirical evidence froma small countryperspective.
3. Methodology
3.1 Data and sources
A monthly time series data for the period 1980:01 to 2009:04 is used for this study.
Information on in?ation series and US dollar-Ghana cedi exchange rate, broad money
supply and petrol prices are used. Pre-targeting sample period ranges from 1990:01 to
2001:12 and the post-targeting period ranges from 2002:01 to 2008:12. The source of the
data is Bank of Ghana and Ghana Statistical Services.
3.2 Empirical model
The study adopts a simpli?ed version of the model in Pe´tursson (2004) for pure time
series data. An AR(1) model with IT and selected macroeconomic series as exogenous
In?ation
targeting
in Ghana
29
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variables is speci?ed; thus in?ation was speci?ed as a function of its ?rst lag, a dummy
representing IT and a control for external shocks. The utilization of the AR process is
informed by its appropriateness in similar studies due to the nature of the variables
and the dataset:
p
t
¼ a þb
p
IT þg
p
p
t21
þdX
t21
þm
t
ð1Þ
where p
t
represents in?ation rate at time t, and IT
t
is a dummy variable with IT ¼ 0 if
t , TB and IT ¼ 1 if t $ TB þ 1. TB represents the implementation date of IT. X
t21
in the model represents a vector of lagged control variables. The model also includes
lagged own in?ation to account for a possible bias due to potential correlation between
the dummy variable and past in?ation performance, i.e. if high in?ation recorded in
previous periods accounts for the choice of IT. Macroeconomic shocks may account for
apparent deviation of in?ation rates from target levels. It is, therefore, imperative that
the study control for economic shocks including domestic price of petrol, growth rate of
broad money and exchange rate depreciation. The above model is modi?ed to include
growth rate of oil price, broad money supply and exchange rate depreciation rate as
speci?ed in equation (2):
p
t
¼ a þb
p
IT þg
p
p
t21
þvP
t21
þdDev
t21
þuMgr
t21
þm
t
ð2Þ
where Mgr represents growth rate of broad money supply and Dev is the rate of
exchange rate depreciation. P is the change in X-pump price of oil. Mishkin and
Schmidt-Hebbel (2007) argued that innovations are expected to have less pass through
effect to in?ation in the presence of IT. This paper tests the validity of this conclusion
by modifying equation (2) to include an interactive term between IT and the
macroeconomic shocks to assess the strength of the pass through effect to in?ation.
The rationale is to assess the evidence of a reduction in the pass through effect
emanating from the interactive term:
p
t
¼ a þb
p
IT þg
p
p
t21
þvPgr
t21
þdDev
t21
þuMgr
t21
þ
X
w
i
IT
*
ðP
t21
þ Dev
t21
þ Mgr
t21
Þ þm
t
ð3Þ
Signi?cant w
i
(i ¼ 1, 2 and 3) indicate a high pass through effect of macroeconomic
shocks to in?ation even in the presence of IT inconsistent with Mishkin and
Schmidt-Hebbel (2007).
3.3 Estimation technique
Traditional ordinary least squares yields unbiased but inef?cient estimates in the
presence of serial correlation and heteroskedasticity in m
t
. The paper uses a regression
with Newey-West standard errors. m
t
is assumed to be heteroskedastic[1] and possibly
autocorrelated up to some lag. The control variables are stationary[2] at levels.
3.3.1 In?ation persistence. Most macroeconomic series respond slowly and for a
long period to innovations hence are said to be non-stationary. Pe´tursson (2004) and
Kuttner and Posen (1999) suggest that the impact of innovations should die out quickly
or should have less persistent effects on in?ation under IT regime. Pe´tursson (2004)
and Kuttner and Posen (1999) analyzed the impact of IT on persistence of in?ation
using an autoregressive process of order one, AR (1). This paper generalizes the
autoregressive process to order p. An interactive term between IT dummy and the ?rst
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lag of in?ation included to act as the terminal point of the in?ation persistence
consistent with Kuttner and Posen (1999). The AR (p) process is as follows:
p
t
¼ a
0
þ
X
p
i¼1
f
i
p
t21
þu
1
ITp
t21
þ1
t
ð4Þ
The choice of the lag order (p) is based on Hannan Quine information criterion, Schwartz
information criterion and Bayesian information criterion. The memory of the in?ation
process is given by
P
p
i¼1
f
i
prior to targeting and by
P
p
i¼1
f
i
þu
1
after targeting.
A signi?cantly negative u
1
would suggest that in?ation persistence had fallen so
that the durability of the effects of temporary price shocks on in?ation had decreased.
4. Discussion of empirical ?ndings
4.1 Descriptive statistics on key variables
The data on in?ation and other macroeconomic series show signi?cant variation over
the two periods; for instance in?ation, measured by percentage change in the CPI,
declined from an average of 31.85 per cent between January 1997 and December 2001 to
16.4 per cent between 2002 and 2008. Volatility of in?ation also declined signi?cantly
with the standard deviation falling from 15.6 to 5.2. In the pre-IT period, the minimum
in?ation recorded was about 12.4 per cent and a maximum of 66.4 per cent compared to
9.5 and 31 per cent in the post-IT period.
This result is supported by Figures 1 and 2. During the period prior to 2002, Ghana had
anexperience of volatile and high-level in?ation rates (peaking at 40.5 per cent inDecember
2000). This was explained by increased crude oil prices and decline in cocoa prices in the
international market. Over the two years (2007 and 2008) year-on-year in?ation (monthly)
remained relatively lowaveraging 14.7 per cent peaking at 18.2 per cent in December 2008,
even in the phase of global ?nancial decay and escalating crude oil prices. This supports
arguments for increasing importance of ITfor price stabilityin Ghana. In?ation was stable
for most part of the late-2006 to the early 2008 but began to pick up gradually by the mid of
2008 following the rise in international price of crude oil (Table II).
Figure 1 shows monthly in?ation rates and targets for pre- and post-IT regime.
Visual inspection of the absolute differences between in?ation and target levels
Figure 1.
Trajectory of in?ation
(pre- and post-IT)
Actual Inflation
Inflation Target
10
20
30
40
2000 m1 2001 m1 2002 m1 2003 m1 2004 m1
period
Inflation Performance
Under Monetary Targeting
Actual Inflation
Inflation Target
5
10
15
20
25
2004 m1 2005 m1 2006 m1 2007 m1 2008 m1 2009 m1
period
Inflation Performance
Under Inflation Targeting
In?ation
targeting
in Ghana
31
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suggests that variation of in?ation from targets has been much less in the post period
than the pre-IT period. The study observed wide variations in in?ation from targets in
the pre-targeting period compared to the post-period.
Figure 2 compares ?uctuations in in?ation before and after IT (using standard
deviations). It is clear that ?uctuations in in?ation have decreased after IT. This should
not be unexpected considering the reduction in in?ation as shown in Table I given
the close relationship between ?uctuations in in?ation and the level of in?ation.
The ?gure shows that ?uctuations in the monetary aggregate targeting regime
(pre-IT regime) remained relatively high consistent with high-average in?ation rates
over the same period. Decline in volatility of in?ation might indicate the success of ITP
in the management of in?ation in Ghana since its adoption.
4.2 Impact of macroeconomic series
Fluctuations in in?ation from targets are partly the result of macroeconomic shocks
such as increasing crude oil prices, drought that last for more than a quarter and broad
money growth and exchange rate shocks but these innovations are expected to have
less pass through effect to in?ation in the presence of IT, Mishkin and Schmidt-Hebbel
(2007). They argued that:
If in?ation targeting improves the credibility of monetary policy and the anchoring of
in?ation expectations, then the study would expect that in?ation would respond less to oil
Figure 2.
In?ation volatility
0
5
10
15
20
d
e
v
2000 m1 2001 m1 2002 m1 2003 m1 2004 m1
period
Volatility of Inflation
Under Monetary Targeting Procedure
0
5
10
15
20
d
e
v
2003 m7 2005 m1 2006 m7 2008 m1 2009 m7
period
Volatility of Inflation
Under Inflation Targeting Procedure
Variable Mean SD Min. Max.
Pre-IT
In?ation (DCPI) 31.85476 15.62892 12.4 66.400
M2 þ growth rate 0.025807 0.022436 20.0140 0.07710
Dollar growth rate 0.023001 0.029691 20.0087 0.14796
Petrol price growth 0.0285 0.11390 20.1640 0.7793
Post-IT
In?ation (DCPI) 16.38595 5.272108 9.5000 31.1000
M2 þ growth rate 0.023614 0.028366 20.0366 0.095211
Dollar growth rate 20.10356 1.00547 29.2088 0.04567
Petrol price growth 0.01830 0.0908 20.1985 0.5465
Table II.
Summary statistics
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price shocks under in?ation targeting and there would be less of a pass-through effect from
exchange rate shocks. As a result of increased credibility and reduced devaluation to in?ation
pass-through, in?ation targeting may also reinforce monetary policy independence
(Mishkin and Schmidt-Hebbel, 2007, p. 9).
Figure 3 shows in?ation response to oil price and exchange rate shocks between IT
regime and pre-IT regime. Prior to the introduction of IT, petrol prices, money supply
and exchange rate largely dictated the movement or direction of in?ation series. It is
clear that the direction of in?ation mimics exchange rate and oil prices. The study
observes that although petrol prices and exchange rate continued to rise, in?ation rates
remained stable for most part of 2004-2008; indicating a less pass through impact of oil
prices and exchange rate to in?ation.
Similar trend is observed with the impact of broad money supply growth. In?ation
rate responds much more rapidly to monetary growth in the pre-IT period than in the
post-IT era.
Figure 3.
The in?uence of
macroeconomic series
–0.2
0
0.2
0.4
0.6
–0.2
0
0.2
0.4
0.6
10
20
30
40
i
n
f
l
a
t
i
o
n
2000 m1 2000 m7 2001 m1 2001 m7 2002 m1
period
year on year inflation pgr
Inflation vs. Petrol Prices
Monetary Base Regime
p
e
t
r
o
l
p
r
i
c
e
s
10
15
20
25
30
2002 m1 2003 m1 2004 m1 200 5m1 2006 m1 2007 m1
period
year on year inflation pgr
Inflation vs. Petrol Prices
Inflation Targeting Regime
0
0.05
0.1
0.15
10
15
20
25
30
35
40
i
n
f
l
a
t
i
o
n
2000 m1 2000 m7 2001 m1 2001 m7 2002 m1
period
year on year inflation exgr
Inflation vs. Exchange Rate
Monetary Base Regime
e
x
c
h
a
n
g
e
r
a
t
e
10
15
20
25
30
2002 m1 2003 m1 2004 m1 2005 m1 2006 m1 2007 m1
period
year on year inflation exgr
Inflation vs. Exchange Rate
Inflation Targeting Regime
0
0.005
0.01
0.015
0.02
0.025
0
0.02
0.04
0.06
0.08
10
15
20
25
30
35
40
i
n
f
l
a
t
i
o
n
2000 m1 2000 m7 2001 m1 2001 m7 2002 m1
period
year on year inflation mgr
Inflation vs. Monetary Growth Rate
Monetary Base Regime
–0.05
0
0.1
0.05
M
o
n
e
t
a
r
y
G
r
o
w
t
h
R
a
t
e
10
15
20
25
30
2002 m1 2003 m1 2004 m1 2005 m1 2006 m1 2007 m1
period
year on year inflation mgr
Inflation vs. Monetary Growth Rate
Inflation Targeting Regime
Source: Bank of Ghana
In?ation
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4.3 The effects of IT on in?ation series in Ghana
The effect of IT is generally found to be statistically signi?cant at 10 per cent; and
improves to 5 per cent after accounting for changes in selected macroeconomic series
including growth rate of broad money (M2 þ )[3], growth rate of petrol prices and
?uctuations in the cedi-dollar exchange rate as shown in Table III. The coef?cient of IT
is negative indicating that IT has resulted in signi?cant reduction in in?ation series
over the last ?ve years. The ?ndings are consistent with the ?ndings of Almeida and
Goodhart (1996), Laxton et al. (1994), Fillion and Le´onard (1997), Bernanke et al. (1999),
Choi et al. (2003), Pe´tursson (2004), Mishkin (2007) and Condon (2006). Thus, ITP has
since its inception anchored in?ation expectations through consistency and credibility
in announcing and implementing monetary policies, more ?rmly than under the
monetary aggregate targeting regime. This may be responsible for the relatively
superior showing of the economy in response to in?ation shocks consistent with the
?ndings of Condon (2006). These results suggest that IT accompanied by increasing
transparency and accountability has led to improved understanding and greater
credibility of monetary policy. The long run impact of IT improves signi?cantly after
controlling for selected macroeconomic shocks as seen in Table III.
4.4 In?ation persistence and IT
How long does it take for innovation to impact in?ation? Existing literature are divided
on in?ation persistence in the phase of IT. Using the procedure of Natalucci and Piger
(2004) and later by Pe´tursson (2004) the paper estimates an AR(3) model with the
inclusion of an interactive term between IT and in?ation rate as an exogenous variable.
Natalucci and Piger (2004) suggest that a signi?cantly negative coef?cient of the
interactive term indicate low persistence. The results are shown in Table IV. Results
show that the interactive term is negative and signi?cant at 10 per cent (in italics).
These results are consistent with the ?ndings in Levin and Piger (2004), Natalucci and
Piger (2004) and Mishkin and Schmidt-Hebbel (2007) and pointing toward the fact that
in?ation series are stationary under IT but posses unit root under the previous era.
This result is supported by tests for unit root using Augmented Dickey Fuller (ADF)
Estimator NW1 NW2 NW3
g
p
0.9707
* * *
(0.01499) 0.9478
* * *
(0.0158) 0.1011
* * *
(0.0208)
b
p
20.04064
*
(0.02105) 20.1118
* *
(0.0548) 20.21535
* * *
(0.6411)
u 20.2683
* * *
(0.0819) 0.64751 (0.9413)
v 0.2709
* * *
(0.0818) 0.6169 (0.4874)
d 0.1458
* * *
(0.0426) 0.2781
* *
(0.1326)
w
1
0.67859 (0.1082)
w
2
20.64183
* *
(0.2499)
w
3
0.2565
* * *
(0.0837)
a 0.07563
* *
(0.03261) 20.7338
* *
(0.3349) 20.35960 (0.4831)
N 109 109 108
F 1286.62 1047.167 674.14
F . Prob. 0.0000 0.0000 0.0000
R
2
0.9738 0.984623
Legend b/se
Notes: Signi?cant at:
*
10,
* *
5 and
* * *
1 per cent levels; values in parentheses are standard errors
Table III.
Impact assessment of IT
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test for unit root and Clemente et al. (CMR) unit root tests and Zivot and Andrews (ZA)
test for unit root. The ZA test allows for one endogenous break whiles CMR test
includes multiple breaks determined endogenously.
The result above suggests signi?cant reduction in in?ation persistence following the
introduction of ITP which is also supported by tests for stationarity using the ADF and
KPSS tests and those allowing for endogenous structural breaks. The ADF tests the null
hypothesis of non-stationary series against the alternate of stationarity. Unlike the ADF,
KPSS tests the null of stationarity against the presence of unit root. The results of the
unit root tests are shown in Table V. The results show that the null hypothesis of unit
root in in?ation series cannot be rejected at 5 per cent using the ADF and the null of no
unit root or stationary series is rejected using the Kwiatkowski, Phillips, Schmidt, Shin
(KPSS) (1992) test. The tests allowing for endogenous breaks are shown in Table VI and
yield same conclusions. In this regard, the study shows that in?ation persistence is much
lower under IT regime but high in the pre-IT period; suggesting that the impact of
exogenous shocks die out faster in the post-ITP era relative to the monetary aggregate
targeting regime consistent with Levin et al. (2004) and Levin and Piger (2004).
Coef?cients SE T P . jtj
f
1
0.884447 0.056131 15.76 0.0000
f
2
21.03352 0.087911 211.76 0.0000
f
3
0.127372 0.054904 2.32 0.0220
u
1
20.01424 0.007186 21.98 0.0500
a
0
0.601467 0.180105 3.34 0.0010
Observations 112
R
2
0.9588
F-statistics 114.71
F-probability 0.0000
Table IV.
Test for in?ation
persistence
Pre-IT regime Post-IT regime
Variable ADF KPSS ADF KPSS
In?ation 20.115 (0.9479) 0.218 (at lag 5) 23.302 (0.0148) 0.195 (at lag 5)
Notes: Critical values of KPSS test: 10 per cent: 0.119 5 per cent: 0.146 2.5 per cent: 0.176 1 per cent:
0.216; values in parentheses are Mackinnon p-values
Table V.
Unit root test on in?ation
Minimum t-statistic Critical values Break dates
Variable Test Pre Post 1% 5% 10% du1 Du2
In?ation CMR AO 23.259 25.690 Nil 25.49 Nil 2003 m2 2005 m3
IO 24.934 25.842 Nil 25.49 Nil 2002 m1 2005 m2
ZA Both 23.983 26.037 25.57 25.08 Nil Nil 2002 m8
Note:
a
All regressors are stationary at level
Table VI.
Unit root test in the
presence of endogenous
breaks
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5. Conclusions and recommendations
After its emergence in the 1990s in New Zealand, IT has caught on with a number of
countries both developed and developing primarily as a result of its acclaimed bene?ts.
In spite of the perceived advantages of IT, less research has been done especially in
developing economies such as Ghana. Ghana adopted the IT framework in 2002 and
therefore this study examined howits adoption has affected the management of in?ation
in the country. Increased popularity coupled with growing stability of consumer prices
in Ghana, since the introduction of ITP, called for the evaluation of its bene?ts in
comparison to monetary aggregate targeting regime adopted between 1983 and 2002.
The result indicated that IThas had important impact on in?ation management over the
last decade. The study found IT to have signi?cantly reduced average in?ation rate and
volatility over the last eight years. It is also observed that although in?ation responds to
macroeconomic shocks, the pass through impact is lower in the post-ITregime. Relative
to monetary aggregate targeting regime implemented until 2002, IT has improved the
credibility of monetary policy (and its authorities) and strengthened the anchoring of
in?ation expectations, and has therefore led to reduction of in?ation’s response to
macroeconomic shocks and lessened the pass-through effects. The paper further tested
for in?ation persistence (the possible presence of unit root) after the introduction of IT
and concluded that persistence had reduced signi?cantly. The paper also shows that the
impact of exogenous shocks die out faster in the IT framework regime relative to the
pre-IT framework era.
The paper suggest that the relative stability of in?ation in the Ghanaian economy is
the result of ITP which brought with it transparency and accountability of the central
bank. Thus, consolidation of the above success requires that the adoption of minimal
burden of ?nancing government de?cits by the central bank; and a strong degree of
central bank independence particularly instrument independence.
Notes
1. White’s test for heteroskedasticity and Durbin-H statistics are shown in appendix. The
Durbin-H statistics yield superior results compared to the traditional Durbin Watson test
(DW) due to the presence of lagged dependent variable as a regressor.
2. Test for stationarity is done using the Augmented Dickey Fuller (ADF) test and Clemente,
Montanes and Reyes (1998). The latter allows for endogenously determined structural
breaks.
3. M2 þ comprises narrow money (M1), savings and time deposits, certi?cates of deposit and
foreign currency deposits with the Deposits Money Banks.
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the transmission mechanism”, Working Paper No. 01/102, International Monetary Fund,
Washington, DC, July.
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decade of world experience”, International Journal of Finance & Economics, Vol. 6 No. 4,
pp. 343-68.
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development”, Policy Brief No. 14.
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Working Paper No. 2003-027B, Federal Reserve Bank, St Louis, MO.
IMF (2005), World Economic Outlook, International Monetary Fund, Washington, DC.
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countries”, Review of Economics and Statistics, Vol. 85 No. 4, pp. 1076-87.
Mbo, T.T. (2005), The Objectives and Importance of In?ation Targeting, The South African
Reserve Bank.
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Journal of Monetary Economics, Vol. 43 No. 3, pp. 579-606.
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pp. 317-32.
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Series No. 8397, National Bureau of Economic Research, Cambridge, MA.
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do the study know and what do the study need to know?”, in Loayza, N. and Soto, R. (Eds),
In?ation Targeting: Design, Performance, Challenges, Central Bank of Chile, Santiago,
pp. 171-219.
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Schaechter, A., Stone, M.R. and Zelner, M. (2000), “Adopting in?ation targeting: practical issues
for emerging countries”, Occasional Paper No. 202, International Monetary Fund,
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industrial countries”, Review, Federal Reserve Bank, St Louis, MO.
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Svensson, L.E.O. (1999), “In?ation targeting as a monetary policy rule”, Journal of Monetary
Economics, Vol. 43, pp. 607-54.
Svensson, L.E.O. (2002), “Monetary policy and real stabilization”, Rethinking Stabilization Policy:
A Symposium Sponsored by the Federal Reserve Bank of Kansas City, Federal Reserve
Bank for Kansas City, Kansas City, MO.
(The Appendix follows overleaf.)
Corresponding author
Anthony Kyereboah-Coleman can be contacted at: [email protected]
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Figure A1.
Clemente, Montanes and
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doc_976475284.pdf
The Ghanaian economy has experienced relative stability, improved macroeconomic
performance and resilience over the past few years, following the introduction of a new monetary
policy framework called inflation targeting (IT). The purpose of this paper is to look at IT and its effect
on inflation management in Ghana.
Journal of Financial Economic Policy
Inflation targeting and inflation management in Ghana
Anthony Kyereboah-Coleman
Article information:
To cite this document:
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Financial Economic Policy, Vol. 4 Iss 1 pp. 25 - 40
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In?ation targeting and in?ation
management in Ghana
Anthony Kyereboah-Coleman
Department of Finance, University of Ghana Business School,
University of Ghana, Accra, Ghana
Abstract
Purpose – The Ghanaian economy has experienced relative stability, improved macroeconomic
performance and resilience over the past few years, following the introduction of a new monetary
policy framework called in?ation targeting (IT). The purpose of this paper is to look at IT and its effect
on in?ation management in Ghana.
Design/methodology/approach – The study employed monthly time series data from1980 to 2009.
Findings – The results gathered in this study demonstrate that IT has had a signi?cant impact on
the reduction of in?ation series in recent years and has reduced the persistence of in?ation series
considerably. It is largely ampli?ed that the implementation of an IT framework in Ghana has been a
success and has contributed to a change in the conduct of monetary policy towards best practice.
Research limitations/implications – The study could have used a lot more macroeconomic
variables.
Practical implications – The paper’s ?ndings are very important for Central Banks that are using
the IT framework, or planning to do so, for ef?ciency and effectiveness.
Originality/value – The paper is the ?rst of its kind for developing countries, especially in Africa
and Ghana for that matter.
Keywords Ghana, Monetary policy, Macroeconomics, In?ation, Open economy macroeconomics,
In?ation targeting
Paper type Research paper
1. Introduction and background
Since the introduction of In?ation Targeting Policy (ITP) in New Zealand in the early
1990s, evidence of it impact on in?ation management led some central banks from
industrialized and transition or emerging economies of the third world to adopt ITP as a
preferred framework for monetary policy. Due in part to its perceived ef?cacy, ITP has
replaced monetary targeting framework, exchange rate and prices as the most ef?cient
framework for managing commodity prices. Apart from the partial response to
the success story of New Zealand, the overwhelming acceptance of this framework,
according to (Pe´tursson, 2004, p. 1), is credited to the fact that IT combines two aspects
considered important for successful monetary policy, i.e. providing a credible
medium-term anchor for in?ation expectations and at the same time allowing central
banks enough leverage to respond to short-run shocks without endangering the
credibility of the framework.
In broad terms, the ITP framework involves “the public announcement of IT, coupled
with a credible and accountable commitment on the part of government policy
authorities to the achievement of these targets” (Setter?eld, 2006, p. 653). In addition, IT
is usually associated with appropriate changes in the central bank law that enhances
The current issue and full text archive of this journal is available at
www.emeraldinsight.com/1757-6385.htm
JEL classi?cation – C22, E31, E52
In?ation
targeting
in Ghana
25
Journal of Financial Economic Policy
Vol. 4 No. 1, 2012
pp. 25-40
qEmerald Group Publishing Limited
1757-6385
DOI 10.1108/17576381211206460
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the independence of the institution. In practice, while few central banks reach the “ideal”
of being “fully ?edged” IT, many others still focus on ?ghting in?ation to the virtual
exclusion of other goals. ITinvolves several elements including: public announcement of
medium-term numerical target for in?ation; an institutional commitment to price
stability as the primary long run goal of monetary policy and a commitment to achieve
the in?ation goal; an information-inclusive approach in which many variables are used
in making decisions about monetary policy; increased transparency of the monetary
policy process through communication with the public and the markets about objectives
of monetary policymakers and increased accountability of the central bank for attaining
its in?ation goals (Svensson, 2007;Mishkin,2007, pp. 402-3). The preference for IT over
other frameworks is due in part to the fact that the framework provides credible anchor
for monetary policy over the medium-term.
Bank of Ghana (i.e. The Central Bank of Ghana) emphasized in its announcement of
early 2002 indicated the adoption of IT as the framework for the conduct of monetary
policy, marking an end to monetary aggregates targeting regime which had been in use
for over two decades since 1983 with the introduction of the Economic Recovery
Program. The core motive, according to the monetary authorities, for this switch was
to reduce the volatility of in?ation and also to enhance transparency. Accompanying
this announcement was the creation of monetary policy committee, independent of
government and responsible for quarterly formulation and reviewing of monetary
policy, based on medium to long-term targets. In this process, the policy rate (i.e. prime
rate) is used as an instrument for correcting deviations of in?ation from target.
The general assertion on the trajectory of in?ation in Ghana is that the relative
stability of in?ation over the last few years could be attributed to the adoption of IT
and that in spite of the global recession the Ghanaian economy has remained relatively
resilient with in?ation remaining relatively low reaching single digit recently.
Data on in?ation and other macroeconomic series show signi?cant variation over the
two periods (pre- and post-IT); for instance year onyear in?ation, measured bypercentage
change in the consumer price index (CPI), declined from an average of 31.85 per cent
between January 1997 and December 2001 to 16.4 per cent between 2002 and 2008.
Volatility of in?ation also declined signi?cantly with the standard deviation falling from
15.6 to 5.2. In the pre-IT period, the minimum in?ation recorded was about 12.4 per cent
and a maximumof 66.4 per cent compared to 9.5 and 31 per cent in the post-ITperiod. The
question is “has the adoption of IT enhanced the management of in?ation in Ghana?”
Answer to this question is not readily available since no study has been carried out to
examine scienti?cally the issue. This is the thrust of the present study. Thus, the basic
objective is to empirically examine the relationship between IT and in?ation series in
Ghana and also to assess the extent of in?ation persistence, and ?nally to examine the
pass through effect of macroeconomic series to in?ation after the introduction of IT.
The rest of the paper is organized as follows: Section 2 discusses the literature;
Section 3 looks at methodology; Section 4 is devoted to the discussion of empirical
?ndings; and Section 5 concludes the study.
2. Review of literature
2.1 Theoretical literature
2.1.1 Monetary policy regimes. In practice, monetary policy involves modifying the
amount of base currency (M0) in circulation. The distinction between the various types
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of monetary policy lies primarily with the set of instruments and target variables that
are used by the monetary authority to achieve their goals. Table I provides a summary
of monetary policy regimes.
2.1.2 In?ation targeting. Under this policy approach the target is to keep in?ation,
under a particular de?nition such as CPI, within a desired range. The in?ation target is
achieved through periodic adjustments to the Central Bank interest rate target. The
interest rate used is generally the interbank rate at which banks lend to each other
overnight for cash ?ow purposes. The interest rate target is maintained for a speci?c
duration using open market operations. Typically the duration that the interest rate
target is kept constant will vary between months and years and is usually reviewed on a
monthly or quarterly basis by a policy committee. Changes to the interest rate target are
made in response to various market indicators in an attempt to forecast economic trends
and in so doing keep the market on track towards achieving the de?ned in?ation target.
IT framework increases transparency and accountability as the central bank must
publicly divulge its precise target for monetary policy and also successes and failures
are readily apparent to all. The main drawback of IT is that in?ation responds to policy
actions only with a long lag. As a result, the Central Bank cannot easily judge which
policy actions are needed in order to hit the in?ation target and the public cannot easily
determine whether the central bank is living up to its promises. In this situation, IT
central banks may badly miss their targets, losing credibility as a result.
2.1.3 Price level targeting. Price level targeting is similar to IT except that the CPI
growth in one year is offset in subsequent years such that over time the price level on
aggregate does not move. Something similar to price level targeting was tried by
Sweden in the 1930s, and seems to have contributed to the relatively good performance
of the Swedish economy during the Great Depression.
2.1.4 Monetary aggregates. This approach is also sometimes called monetarism.
While most monetary policy framework focuses on a price signal of one form or
another, this approach is focused on monetary quantities.
2.1.5 Fixed exchange rate. This policy is based on maintaining a ?xed exchange rate
with a foreign currency. There are varying degrees of ?xed exchange rates, which can be
ranked in relation to howrigid the ?xed exchange rate is with the anchor nation. Under a
system of ?at ?xed rates, the local government or monetary authority declares a ?xed
exchange rate but does not actively buy or sell currency to maintain the rate. Instead, the
rate is enforced by non-convertibility measures. In this case, there is a black market
exchange rate where the currency trades at its market/unof?cial rate. Under a systemof
?xed-convertibility, currency is bought and sold by the central bank or monetary
authority on a daily basis to achieve the target exchange rate. This target rate may be a
?xed level or a ?xed band within which the exchange rate may ?uctuate until
Monetary policy Target market variable Long term objective
In?ation targeting Interest rate on overnight debt A given rate of change in the CPI
Price level targeting Interest rate on overnight debt A speci?c CPI number
Monetary aggregates The growth in money supply A given rate of change in the CPI
Fixed exchange rate The spot price of the currency The spot price of the currency
Gold standard The spot price of gold Low in?ation as measured by the gold price
Mixed policy Usually interest rates Usually unemployment þ CPI change
Table I.
Monetary policy regimes
In?ation
targeting
in Ghana
27
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the monetary authority intervenes to buy or sell as necessary to maintain the exchange
rate within the band. Hence, the ?xed exchange rate with a ?xed level can be seen as a
special case of the ?xed exchange rate with bands where the bands are set to zero. Under
a system of ?xed exchange rates maintained by a currency board every unit of local
currency must be backed by a unit of foreign currency to correct for the exchange rate.
This ensures that the local monetary base does not in?ate without being backed by hard
currency and eliminates any worries about a run on the local currency by those wishing
to convert the local currency to the anchor currency. These policies often abdicate
monetary policy to the foreign monetary authority or government, as monetary policy in
the pegging nation must align with monetary policy in the anchor nation to maintain the
exchange rate. The degree to which local monetary policy becomes dependent on the
anchor nation depends on factors such as capital mobility, openness, credit channels and
other economic factors.
2.2 Empirical literature
The success of IT in New Zealand and for most other adopters ignited lots of empirical
studies into the effectiveness of IT in reducing in?ation volatility. Several researchers
have attempted to check whether the adoption of IT creates a structural change in an
economy. Two main divergent conclusions are drawn from empirical literature: on one
hand, some economists conclude that the IT makes no statistical difference to the
macroeconomic performance of IT countries (Huh, 1996; Bernanke and Mihov, 1998;
Lane and van den Heuvel, 1998; Bernanke et al., 1999; Honda, 2000; da Silva and
Portugal, 2000). Some of them prove that IT does not cause a structural break in the
in?ation rate path. For instance, Ball and Sheridan (2003, 2005) provide evidence on the
irrelevance of IT.
Other notable authors show paradoxical conclusions (Almeida and Goodhart, 1996;
Batini and Laxton, 1994; Fillion and Le´onard, 1997; Choi et al., 2003; Pe´tursson, 2004;
Mishkin, 2007). They conclude that the ITP reduces in?ation persistence and causes a
structural break in the in?ation dynamic. Mishkin (2007, p. 406) in enumerating the
bene?ts of IT asserts that IT countries seem to have signi?cantly reduce both the rate
of in?ation and in?ation expectations beyond what would is likely to have occurred in
the absence of IT. Condon (2006) suggests that Bank of Korea’s policy of IT seems to
have anchored in?ation expectations more ?rmly than in the previous regime and this
may be responsible for the superior performance of the economy in response to
in?ation shocks. Pe´tursson (2004) compares the average standard deviation of actual
in?ation in the ?ve years before and after the introduction IT and suggests that
adoption of IT contributes to reduced ?uctuations in in?ation. Bernanke et al. (1999),
despite favouring IT, report widespread evidence that IT central banks do not reduce
in?ation at a cost lower than other countries’ central banks in terms of forgone output
(sacri?ce ratio). Bernanke (2003, p. 1) suggests that:
[. . .] central banks that have switched to in?ation targeting have generally been pleased with
the results they have obtained; the strongest evidence on that score is that, thus far at least,
none of the several dozen adopters of in?ation targeting has abandoned this approach.
Johnson (2002) by comparing ?ve IT nations to six non-IT nations, all of them in
industrialized economies, ?nds that the period after the announcement of IT is
associated with a statistically signi?cant reduction in the level of expected in?ation.
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Neumann and von Hagen (2002) considered a group of six industrialized IT countries
and three non-IT countries and performed an event study to quantify the response of
in?ation and long run as well as short-run interest rates to supply shocks. They found
that the effect of IT is not signi?cantly different from zero for average in?ation, but it is
for interest rates, meaning a gain in credibility among in?ation targeters. Vegaa and
Winkelried (2005) using the differenced in difference estimator on selected
industrialized and emerging economies ?nd that IT has helped in reducing the level
and volatility of in?ation in the countries that adopted it.
In a comparative study on the persistence of in?ation using ?ve users and seven
non-users of IT, Levin et al. (2004); observed that in?ation was stationary but the
hypothesis of unit root could not be rejected for non ITnations. Levin and Piger (2004) in a
similar empirical study using 12 industrial countries, and allowing for structural breaks
?nds that in?ation, in general, exhibits low persistence. Their results also suggest that
that ITdoes not appear to have a large impact on long-termexpected in?ation for a group
of 11 emerging market economies. Findings of Pe´tursson (2004) again suggest that IT
reduces in?ation persistence but a contrary view is held by Ball and Sheridan (2005).
Dueker and Fisher (2006) provide comparative analysis by matching three IT
countries (New Zealand, Canada and the UK) with three nearby non-IT countries
(Australia, the USA and Germany), and ?nd little evidence that an IT regime performs
better than a non-IT regime. Gonc¸alves and Carvalho (2009), however, show that IT
OECD countries suffer smaller output losses in terms of sacri?ce ratio during the
disin?ationary period than non-targeting counterparts. Angeriz and Arestis (2008)
employing intervention analysis ?nd lower in?ation rates, well-anchored and accurate
in?ation expectations for both targeting and non-targeting countries. In the foregoing
analysis, there is ample evidence in support of the bene?ts associated with IT. Those
countries which adopted IT, managed to reduce in?ation to low levels and to curb
in?ation and interest rate volatility. Anecdotal evidence has also been propounded to
make the IT case. Bernanke (2003, p. 1) suggests that:
[. . .] central banks that have switched to IT have generally been pleased with the results they
have obtained. The strongest evidence on that score is that, thus far at least, none of the
several dozen adopters of in?ation targeting has abandoned this approach.
In spite of the pronounced gains emanating from IT, there is little empirics especially in
Africa and for that matter Ghana. This may be due to the lingering acceptance of the IT
concepts by Central Banks on the African continent. This study, therefore, contributes
enormouslyto the debate byprovingempirical evidence froma small countryperspective.
3. Methodology
3.1 Data and sources
A monthly time series data for the period 1980:01 to 2009:04 is used for this study.
Information on in?ation series and US dollar-Ghana cedi exchange rate, broad money
supply and petrol prices are used. Pre-targeting sample period ranges from 1990:01 to
2001:12 and the post-targeting period ranges from 2002:01 to 2008:12. The source of the
data is Bank of Ghana and Ghana Statistical Services.
3.2 Empirical model
The study adopts a simpli?ed version of the model in Pe´tursson (2004) for pure time
series data. An AR(1) model with IT and selected macroeconomic series as exogenous
In?ation
targeting
in Ghana
29
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variables is speci?ed; thus in?ation was speci?ed as a function of its ?rst lag, a dummy
representing IT and a control for external shocks. The utilization of the AR process is
informed by its appropriateness in similar studies due to the nature of the variables
and the dataset:
p
t
¼ a þb
p
IT þg
p
p
t21
þdX
t21
þm
t
ð1Þ
where p
t
represents in?ation rate at time t, and IT
t
is a dummy variable with IT ¼ 0 if
t , TB and IT ¼ 1 if t $ TB þ 1. TB represents the implementation date of IT. X
t21
in the model represents a vector of lagged control variables. The model also includes
lagged own in?ation to account for a possible bias due to potential correlation between
the dummy variable and past in?ation performance, i.e. if high in?ation recorded in
previous periods accounts for the choice of IT. Macroeconomic shocks may account for
apparent deviation of in?ation rates from target levels. It is, therefore, imperative that
the study control for economic shocks including domestic price of petrol, growth rate of
broad money and exchange rate depreciation. The above model is modi?ed to include
growth rate of oil price, broad money supply and exchange rate depreciation rate as
speci?ed in equation (2):
p
t
¼ a þb
p
IT þg
p
p
t21
þvP
t21
þdDev
t21
þuMgr
t21
þm
t
ð2Þ
where Mgr represents growth rate of broad money supply and Dev is the rate of
exchange rate depreciation. P is the change in X-pump price of oil. Mishkin and
Schmidt-Hebbel (2007) argued that innovations are expected to have less pass through
effect to in?ation in the presence of IT. This paper tests the validity of this conclusion
by modifying equation (2) to include an interactive term between IT and the
macroeconomic shocks to assess the strength of the pass through effect to in?ation.
The rationale is to assess the evidence of a reduction in the pass through effect
emanating from the interactive term:
p
t
¼ a þb
p
IT þg
p
p
t21
þvPgr
t21
þdDev
t21
þuMgr
t21
þ
X
w
i
IT
*
ðP
t21
þ Dev
t21
þ Mgr
t21
Þ þm
t
ð3Þ
Signi?cant w
i
(i ¼ 1, 2 and 3) indicate a high pass through effect of macroeconomic
shocks to in?ation even in the presence of IT inconsistent with Mishkin and
Schmidt-Hebbel (2007).
3.3 Estimation technique
Traditional ordinary least squares yields unbiased but inef?cient estimates in the
presence of serial correlation and heteroskedasticity in m
t
. The paper uses a regression
with Newey-West standard errors. m
t
is assumed to be heteroskedastic[1] and possibly
autocorrelated up to some lag. The control variables are stationary[2] at levels.
3.3.1 In?ation persistence. Most macroeconomic series respond slowly and for a
long period to innovations hence are said to be non-stationary. Pe´tursson (2004) and
Kuttner and Posen (1999) suggest that the impact of innovations should die out quickly
or should have less persistent effects on in?ation under IT regime. Pe´tursson (2004)
and Kuttner and Posen (1999) analyzed the impact of IT on persistence of in?ation
using an autoregressive process of order one, AR (1). This paper generalizes the
autoregressive process to order p. An interactive term between IT dummy and the ?rst
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lag of in?ation included to act as the terminal point of the in?ation persistence
consistent with Kuttner and Posen (1999). The AR (p) process is as follows:
p
t
¼ a
0
þ
X
p
i¼1
f
i
p
t21
þu
1
ITp
t21
þ1
t
ð4Þ
The choice of the lag order (p) is based on Hannan Quine information criterion, Schwartz
information criterion and Bayesian information criterion. The memory of the in?ation
process is given by
P
p
i¼1
f
i
prior to targeting and by
P
p
i¼1
f
i
þu
1
after targeting.
A signi?cantly negative u
1
would suggest that in?ation persistence had fallen so
that the durability of the effects of temporary price shocks on in?ation had decreased.
4. Discussion of empirical ?ndings
4.1 Descriptive statistics on key variables
The data on in?ation and other macroeconomic series show signi?cant variation over
the two periods; for instance in?ation, measured by percentage change in the CPI,
declined from an average of 31.85 per cent between January 1997 and December 2001 to
16.4 per cent between 2002 and 2008. Volatility of in?ation also declined signi?cantly
with the standard deviation falling from 15.6 to 5.2. In the pre-IT period, the minimum
in?ation recorded was about 12.4 per cent and a maximum of 66.4 per cent compared to
9.5 and 31 per cent in the post-IT period.
This result is supported by Figures 1 and 2. During the period prior to 2002, Ghana had
anexperience of volatile and high-level in?ation rates (peaking at 40.5 per cent inDecember
2000). This was explained by increased crude oil prices and decline in cocoa prices in the
international market. Over the two years (2007 and 2008) year-on-year in?ation (monthly)
remained relatively lowaveraging 14.7 per cent peaking at 18.2 per cent in December 2008,
even in the phase of global ?nancial decay and escalating crude oil prices. This supports
arguments for increasing importance of ITfor price stabilityin Ghana. In?ation was stable
for most part of the late-2006 to the early 2008 but began to pick up gradually by the mid of
2008 following the rise in international price of crude oil (Table II).
Figure 1 shows monthly in?ation rates and targets for pre- and post-IT regime.
Visual inspection of the absolute differences between in?ation and target levels
Figure 1.
Trajectory of in?ation
(pre- and post-IT)
Actual Inflation
Inflation Target
10
20
30
40
2000 m1 2001 m1 2002 m1 2003 m1 2004 m1
period
Inflation Performance
Under Monetary Targeting
Actual Inflation
Inflation Target
5
10
15
20
25
2004 m1 2005 m1 2006 m1 2007 m1 2008 m1 2009 m1
period
Inflation Performance
Under Inflation Targeting
In?ation
targeting
in Ghana
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suggests that variation of in?ation from targets has been much less in the post period
than the pre-IT period. The study observed wide variations in in?ation from targets in
the pre-targeting period compared to the post-period.
Figure 2 compares ?uctuations in in?ation before and after IT (using standard
deviations). It is clear that ?uctuations in in?ation have decreased after IT. This should
not be unexpected considering the reduction in in?ation as shown in Table I given
the close relationship between ?uctuations in in?ation and the level of in?ation.
The ?gure shows that ?uctuations in the monetary aggregate targeting regime
(pre-IT regime) remained relatively high consistent with high-average in?ation rates
over the same period. Decline in volatility of in?ation might indicate the success of ITP
in the management of in?ation in Ghana since its adoption.
4.2 Impact of macroeconomic series
Fluctuations in in?ation from targets are partly the result of macroeconomic shocks
such as increasing crude oil prices, drought that last for more than a quarter and broad
money growth and exchange rate shocks but these innovations are expected to have
less pass through effect to in?ation in the presence of IT, Mishkin and Schmidt-Hebbel
(2007). They argued that:
If in?ation targeting improves the credibility of monetary policy and the anchoring of
in?ation expectations, then the study would expect that in?ation would respond less to oil
Figure 2.
In?ation volatility
0
5
10
15
20
d
e
v
2000 m1 2001 m1 2002 m1 2003 m1 2004 m1
period
Volatility of Inflation
Under Monetary Targeting Procedure
0
5
10
15
20
d
e
v
2003 m7 2005 m1 2006 m7 2008 m1 2009 m7
period
Volatility of Inflation
Under Inflation Targeting Procedure
Variable Mean SD Min. Max.
Pre-IT
In?ation (DCPI) 31.85476 15.62892 12.4 66.400
M2 þ growth rate 0.025807 0.022436 20.0140 0.07710
Dollar growth rate 0.023001 0.029691 20.0087 0.14796
Petrol price growth 0.0285 0.11390 20.1640 0.7793
Post-IT
In?ation (DCPI) 16.38595 5.272108 9.5000 31.1000
M2 þ growth rate 0.023614 0.028366 20.0366 0.095211
Dollar growth rate 20.10356 1.00547 29.2088 0.04567
Petrol price growth 0.01830 0.0908 20.1985 0.5465
Table II.
Summary statistics
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price shocks under in?ation targeting and there would be less of a pass-through effect from
exchange rate shocks. As a result of increased credibility and reduced devaluation to in?ation
pass-through, in?ation targeting may also reinforce monetary policy independence
(Mishkin and Schmidt-Hebbel, 2007, p. 9).
Figure 3 shows in?ation response to oil price and exchange rate shocks between IT
regime and pre-IT regime. Prior to the introduction of IT, petrol prices, money supply
and exchange rate largely dictated the movement or direction of in?ation series. It is
clear that the direction of in?ation mimics exchange rate and oil prices. The study
observes that although petrol prices and exchange rate continued to rise, in?ation rates
remained stable for most part of 2004-2008; indicating a less pass through impact of oil
prices and exchange rate to in?ation.
Similar trend is observed with the impact of broad money supply growth. In?ation
rate responds much more rapidly to monetary growth in the pre-IT period than in the
post-IT era.
Figure 3.
The in?uence of
macroeconomic series
–0.2
0
0.2
0.4
0.6
–0.2
0
0.2
0.4
0.6
10
20
30
40
i
n
f
l
a
t
i
o
n
2000 m1 2000 m7 2001 m1 2001 m7 2002 m1
period
year on year inflation pgr
Inflation vs. Petrol Prices
Monetary Base Regime
p
e
t
r
o
l
p
r
i
c
e
s
10
15
20
25
30
2002 m1 2003 m1 2004 m1 200 5m1 2006 m1 2007 m1
period
year on year inflation pgr
Inflation vs. Petrol Prices
Inflation Targeting Regime
0
0.05
0.1
0.15
10
15
20
25
30
35
40
i
n
f
l
a
t
i
o
n
2000 m1 2000 m7 2001 m1 2001 m7 2002 m1
period
year on year inflation exgr
Inflation vs. Exchange Rate
Monetary Base Regime
e
x
c
h
a
n
g
e
r
a
t
e
10
15
20
25
30
2002 m1 2003 m1 2004 m1 2005 m1 2006 m1 2007 m1
period
year on year inflation exgr
Inflation vs. Exchange Rate
Inflation Targeting Regime
0
0.005
0.01
0.015
0.02
0.025
0
0.02
0.04
0.06
0.08
10
15
20
25
30
35
40
i
n
f
l
a
t
i
o
n
2000 m1 2000 m7 2001 m1 2001 m7 2002 m1
period
year on year inflation mgr
Inflation vs. Monetary Growth Rate
Monetary Base Regime
–0.05
0
0.1
0.05
M
o
n
e
t
a
r
y
G
r
o
w
t
h
R
a
t
e
10
15
20
25
30
2002 m1 2003 m1 2004 m1 2005 m1 2006 m1 2007 m1
period
year on year inflation mgr
Inflation vs. Monetary Growth Rate
Inflation Targeting Regime
Source: Bank of Ghana
In?ation
targeting
in Ghana
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4.3 The effects of IT on in?ation series in Ghana
The effect of IT is generally found to be statistically signi?cant at 10 per cent; and
improves to 5 per cent after accounting for changes in selected macroeconomic series
including growth rate of broad money (M2 þ )[3], growth rate of petrol prices and
?uctuations in the cedi-dollar exchange rate as shown in Table III. The coef?cient of IT
is negative indicating that IT has resulted in signi?cant reduction in in?ation series
over the last ?ve years. The ?ndings are consistent with the ?ndings of Almeida and
Goodhart (1996), Laxton et al. (1994), Fillion and Le´onard (1997), Bernanke et al. (1999),
Choi et al. (2003), Pe´tursson (2004), Mishkin (2007) and Condon (2006). Thus, ITP has
since its inception anchored in?ation expectations through consistency and credibility
in announcing and implementing monetary policies, more ?rmly than under the
monetary aggregate targeting regime. This may be responsible for the relatively
superior showing of the economy in response to in?ation shocks consistent with the
?ndings of Condon (2006). These results suggest that IT accompanied by increasing
transparency and accountability has led to improved understanding and greater
credibility of monetary policy. The long run impact of IT improves signi?cantly after
controlling for selected macroeconomic shocks as seen in Table III.
4.4 In?ation persistence and IT
How long does it take for innovation to impact in?ation? Existing literature are divided
on in?ation persistence in the phase of IT. Using the procedure of Natalucci and Piger
(2004) and later by Pe´tursson (2004) the paper estimates an AR(3) model with the
inclusion of an interactive term between IT and in?ation rate as an exogenous variable.
Natalucci and Piger (2004) suggest that a signi?cantly negative coef?cient of the
interactive term indicate low persistence. The results are shown in Table IV. Results
show that the interactive term is negative and signi?cant at 10 per cent (in italics).
These results are consistent with the ?ndings in Levin and Piger (2004), Natalucci and
Piger (2004) and Mishkin and Schmidt-Hebbel (2007) and pointing toward the fact that
in?ation series are stationary under IT but posses unit root under the previous era.
This result is supported by tests for unit root using Augmented Dickey Fuller (ADF)
Estimator NW1 NW2 NW3
g
p
0.9707
* * *
(0.01499) 0.9478
* * *
(0.0158) 0.1011
* * *
(0.0208)
b
p
20.04064
*
(0.02105) 20.1118
* *
(0.0548) 20.21535
* * *
(0.6411)
u 20.2683
* * *
(0.0819) 0.64751 (0.9413)
v 0.2709
* * *
(0.0818) 0.6169 (0.4874)
d 0.1458
* * *
(0.0426) 0.2781
* *
(0.1326)
w
1
0.67859 (0.1082)
w
2
20.64183
* *
(0.2499)
w
3
0.2565
* * *
(0.0837)
a 0.07563
* *
(0.03261) 20.7338
* *
(0.3349) 20.35960 (0.4831)
N 109 109 108
F 1286.62 1047.167 674.14
F . Prob. 0.0000 0.0000 0.0000
R
2
0.9738 0.984623
Legend b/se
Notes: Signi?cant at:
*
10,
* *
5 and
* * *
1 per cent levels; values in parentheses are standard errors
Table III.
Impact assessment of IT
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test for unit root and Clemente et al. (CMR) unit root tests and Zivot and Andrews (ZA)
test for unit root. The ZA test allows for one endogenous break whiles CMR test
includes multiple breaks determined endogenously.
The result above suggests signi?cant reduction in in?ation persistence following the
introduction of ITP which is also supported by tests for stationarity using the ADF and
KPSS tests and those allowing for endogenous structural breaks. The ADF tests the null
hypothesis of non-stationary series against the alternate of stationarity. Unlike the ADF,
KPSS tests the null of stationarity against the presence of unit root. The results of the
unit root tests are shown in Table V. The results show that the null hypothesis of unit
root in in?ation series cannot be rejected at 5 per cent using the ADF and the null of no
unit root or stationary series is rejected using the Kwiatkowski, Phillips, Schmidt, Shin
(KPSS) (1992) test. The tests allowing for endogenous breaks are shown in Table VI and
yield same conclusions. In this regard, the study shows that in?ation persistence is much
lower under IT regime but high in the pre-IT period; suggesting that the impact of
exogenous shocks die out faster in the post-ITP era relative to the monetary aggregate
targeting regime consistent with Levin et al. (2004) and Levin and Piger (2004).
Coef?cients SE T P . jtj
f
1
0.884447 0.056131 15.76 0.0000
f
2
21.03352 0.087911 211.76 0.0000
f
3
0.127372 0.054904 2.32 0.0220
u
1
20.01424 0.007186 21.98 0.0500
a
0
0.601467 0.180105 3.34 0.0010
Observations 112
R
2
0.9588
F-statistics 114.71
F-probability 0.0000
Table IV.
Test for in?ation
persistence
Pre-IT regime Post-IT regime
Variable ADF KPSS ADF KPSS
In?ation 20.115 (0.9479) 0.218 (at lag 5) 23.302 (0.0148) 0.195 (at lag 5)
Notes: Critical values of KPSS test: 10 per cent: 0.119 5 per cent: 0.146 2.5 per cent: 0.176 1 per cent:
0.216; values in parentheses are Mackinnon p-values
Table V.
Unit root test on in?ation
Minimum t-statistic Critical values Break dates
Variable Test Pre Post 1% 5% 10% du1 Du2
In?ation CMR AO 23.259 25.690 Nil 25.49 Nil 2003 m2 2005 m3
IO 24.934 25.842 Nil 25.49 Nil 2002 m1 2005 m2
ZA Both 23.983 26.037 25.57 25.08 Nil Nil 2002 m8
Note:
a
All regressors are stationary at level
Table VI.
Unit root test in the
presence of endogenous
breaks
In?ation
targeting
in Ghana
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5. Conclusions and recommendations
After its emergence in the 1990s in New Zealand, IT has caught on with a number of
countries both developed and developing primarily as a result of its acclaimed bene?ts.
In spite of the perceived advantages of IT, less research has been done especially in
developing economies such as Ghana. Ghana adopted the IT framework in 2002 and
therefore this study examined howits adoption has affected the management of in?ation
in the country. Increased popularity coupled with growing stability of consumer prices
in Ghana, since the introduction of ITP, called for the evaluation of its bene?ts in
comparison to monetary aggregate targeting regime adopted between 1983 and 2002.
The result indicated that IThas had important impact on in?ation management over the
last decade. The study found IT to have signi?cantly reduced average in?ation rate and
volatility over the last eight years. It is also observed that although in?ation responds to
macroeconomic shocks, the pass through impact is lower in the post-ITregime. Relative
to monetary aggregate targeting regime implemented until 2002, IT has improved the
credibility of monetary policy (and its authorities) and strengthened the anchoring of
in?ation expectations, and has therefore led to reduction of in?ation’s response to
macroeconomic shocks and lessened the pass-through effects. The paper further tested
for in?ation persistence (the possible presence of unit root) after the introduction of IT
and concluded that persistence had reduced signi?cantly. The paper also shows that the
impact of exogenous shocks die out faster in the IT framework regime relative to the
pre-IT framework era.
The paper suggest that the relative stability of in?ation in the Ghanaian economy is
the result of ITP which brought with it transparency and accountability of the central
bank. Thus, consolidation of the above success requires that the adoption of minimal
burden of ?nancing government de?cits by the central bank; and a strong degree of
central bank independence particularly instrument independence.
Notes
1. White’s test for heteroskedasticity and Durbin-H statistics are shown in appendix. The
Durbin-H statistics yield superior results compared to the traditional Durbin Watson test
(DW) due to the presence of lagged dependent variable as a regressor.
2. Test for stationarity is done using the Augmented Dickey Fuller (ADF) test and Clemente,
Montanes and Reyes (1998). The latter allows for endogenously determined structural
breaks.
3. M2 þ comprises narrow money (M1), savings and time deposits, certi?cates of deposit and
foreign currency deposits with the Deposits Money Banks.
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Svensson, L.E.O. (2007), “Optimal in?ation targeting: further developments of in?ation
targeting”, in Mishkin, F. and Schmidt-Hebbel, K. (Eds), Monetary Policy Under In?ation
Targeting, Banco Central de Chile, Santiago.
Vegaa, M. and Winkelried, D. “In?ation targeting and in?ation behavior: a successful story?”,
Macroeconomics 0502026, EconWPA.
Further reading
Clements, B., Kontolemis, Z.G. and Levy, G. (1999), “Monetary policy under EMU: differences in
the transmission mechanism”, Working Paper No. 01/102, International Monetary Fund,
Washington, DC, July.
Corbo, V., Landerretche, O. and Schmidt-Hebbel, K. (2001), “Assessing in?ation targeting after a
decade of world experience”, International Journal of Finance & Economics, Vol. 6 No. 4,
pp. 343-68.
Epstein, G. and Yeldan, A.E. (n.d.), “In?ation targeting, employment creation and economic
development”, Policy Brief No. 14.
Gavin, W.T. (2003), “In?ation targeting: why it works and how to make it work better”,
Working Paper No. 2003-027B, Federal Reserve Bank, St Louis, MO.
IMF (2005), World Economic Outlook, International Monetary Fund, Washington, DC.
Johnson, D. (2003), “The effect of in?ation targets on the level of expected in?ation in ?ve
countries”, Review of Economics and Statistics, Vol. 85 No. 4, pp. 1076-87.
Mbo, T.T. (2005), The Objectives and Importance of In?ation Targeting, The South African
Reserve Bank.
Mishkin, F.S. (1999), “International experiences with different monetary policy regimes”,
Journal of Monetary Economics, Vol. 43 No. 3, pp. 579-606.
Mishkin, F.S. (2000), “What shouldcentral banks do?”, Review, Federal Reserve Bank, St Louis, MO.
Mishkin, F.S. (2005), “The Fed after Greenspan”, Eastern Economic Journal, Vol. 31 No. 3,
pp. 317-32.
Mishkin, F.S. and Posen, A.S. (1997), “In?ation targeting: lessons from four countries”, Economic
Policy Review, Vol. 3 No. 3, pp. 9-110.
Mishkin, F.S. and Schmidt-Hebbel, K. (2001), “One decade of in?ation targeting in the world:
what do the study know and what do the study need to know?”, NBER Working Paper
Series No. 8397, National Bureau of Economic Research, Cambridge, MA.
Mishkin, F.S. and Schmidt-Hebbel, K. (2002), “One decade of in?ation targeting in the world: what
do the study know and what do the study need to know?”, in Loayza, N. and Soto, R. (Eds),
In?ation Targeting: Design, Performance, Challenges, Central Bank of Chile, Santiago,
pp. 171-219.
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Siklos, P.L. (1998), “In?ation-target design: changing in?ation performance and persistence in
industrial countries”, Review, Federal Reserve Bank, St Louis, MO.
Stevens, G.R. (1999), “Six years of in?ation targeting”, Address to the Economic Society of
Australia, Sydney, 20 April.
Svensson, L.E.O. (1999), “In?ation targeting as a monetary policy rule”, Journal of Monetary
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(The Appendix follows overleaf.)
Corresponding author
Anthony Kyereboah-Coleman can be contacted at: [email protected]
To purchase reprints of this article please e-mail: [email protected]
Or visit our web site for further details: www.emeraldinsight.com/reprints
In?ation
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Appendix
Figure A1.
Clemente, Montanes and
Reyes unit root tests with
two structural breaks
10
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D.infyoy
Clemente-Montañés-Reyes double IO test for unit root
1996 m1 1998 m7 2001 m1 2003 m7 2006 m1
period
Test on exgr: breaks at 1999 m8, 2000 m7
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1996 m1 1998 m7 2001 m1 2003 m7 2006 m1
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D.exgr
Clemente-Montañés-Reyes double IO test for unit root
0
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m
g
r
1995 m1 2000 m1 2005 m1
period
Test on lmgr: breaks at 2002 m10, 2003 m11
1995 m1 2000 m1 2005 m1
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–0.05
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Test on lmgr: breaks at 2002 m9, 2003 m10
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Test on exgr: breaks at 1999 m7, 2000 m8
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–0.15
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1996 m1 1998 m7 2001 m1 2003 m7 2006 m1
period
D.exgr
Clemente-Montañés-Reyes double AO test for unit root
Test on infyoy: breaks at 2002 m1, 2005 m2 Test on infyoy: breaks at 2003 m2, 2005 m3
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