A re-examination of the exchange rate – Interest rate differential relationship in Ghana

Abstract

This study revisits the relationship between the exchange rate and interest rate differential in Ghana with a focus on the period in which the country adopted the inflation targeting regime. Using macro-data spanning 2002 to 2019 for Ghana and the United States, we show the nonexistence of the relationship in both the short-run and long-run. Further, we show a positive but slow responsiveness of the exchange rate to interest rate differential shocks from the short-run to the medium term. The long-run results, however, shows a case of a strong and significant response of exchange rate to interest rate differential shocks. We recommend that the Bank of Ghana (BoG) addresses perennial macroeconomic instability, especially on inflation, which has been shown to fuel investment uncertainty and investment insensitivity to interest rate.

Keywords

• Inflation targeting
• Exchange rate
• Impulse response function
• Interest
• Rate differential
• VAR