The effect of exchange rate volatility on the economic growth in post-exchange rate liberalisation [in] Ghana

Abstract

For decades, Ghana's economy has been highly dependent on the external sector, and therefore remained vulnerable to fluctuations in commodity prices and other shocks in the external sector. Consequently, exchange rate volatility constitutes a major concern for local and foreign traders and investors. While this does not augur well for economic growth in theory, there is limited empirical evidence on the impact of exchange rate volatility on economic growth in Ghana as a small open economy. This study contributes to the literature and policy by modelling exchange rate volatility and analysing its impact on economic growth, with a particular focus on the post-liberalization period 1990-2019. The study utilises an annual time series data over the 30-year period during which Ghana adopted the managed floating exchange rate regime. The study uses the generalized auto-regressive conditional heteroskedasticity (GARCH) statistical model to measure the exchange rate volatility for the study period. Using the ARDL estimation method, the main results of the study indicate that exchange rate volatility serves as a significant drag on economic growth in Ghana both in the long run and short run, with its coefficients being negative and statistically significant in both time horizons. The study provides additional evidence that inflation and interest rate are the channels through which the adverse effects of exchange rate volatility are transmitted to economic growth in Ghana over the study period. The results also show that foreign direct investment, gross capital formation and government expenditure are significant drivers of economic growth in Ghana both in the long run and short run. In the light of these findings, the study concludes that policies aimed at curbing excessive and rapid fluctuations in the Ghana's exchange rate, as well as creating the enabling environment for capital formation and attracting foreign direct investment can be effective in accelerating economic growth in Ghana. The study recommends that good policies must be adopted to sustain inflation rates at the lowest level by government and policymakers. Also, Price stability often contributes to stable interest rate for economic growth, the Central bank must therefore, set up monetary policies such as controlling money supply to stabilize interest rate and inflation in order to help improve economic growth in the country.