THE INTERPLAY OF DEMAND FOR FOREIGN CURRENCIES AND EXCHANGE RATE DYNAMICS IN GHANA

Abdul-Aziz Ibn Musah, Jianguo Du, Seidu Ayishetu, Hira Salah ud din Khan

Abstract


The increasing trend in which Ghanaians hold deposits and loans denominated in foreign currency – notably the U.S. dollar – has generated a lot of controversy in macroeconomic discourse recently. Although the debate has usually been linked to exchange rate volatility and inflation in developing countries practising floating exchange rates, empirical evidence in Africa is still limited. The purpose of this study is to explore the interplay between dollarization, inflation, and exchange rates for the period January 1990 to March 2016. The methodology employed consisted of the Johansen co-integration and vector error correction framework that capture both the short run and long run dynamics of the interplays between the variables. Monthly data for the consumer price index, broad money, and nominal exchange rates were obtained from the International Monetary Fund’s International Financial Statistics (IMF IFS) 2016 online database.The rest of the data; foreign currency deposits and total deposits were also obtained from the Research Department of the Bank of Ghana. After confirming the degree of integration of the variables, the Johansen co-integration approach was implemented to determine whether the variables share any long-run relationships. The finding is that the variables were co-integrated, suggesting a common trend or co-movement of the variables in the long-run. Further, it was reported that there is a positive effect of exchange rate and inflation on dollarization in the long-run. This co-movement brings to bear the predictability of some of the variables using the behaviour of the other variables. The findings highlight that, the ability of the Bank of Ghana to control the high demand for foreign currency depends on its capability of controlling abnormal rates of exchange rate depreciation and high inflation. Also, since persistent depreciation is such as to present deleterious inflation it suggests that the major task for the monetary authority is to control exchange rates.


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