Exchange Rate Pass-Through (ERPT): The inter-connectivity between Exchange Rate and consumer price index in Ghana

Abdul-Aziz Ibn Musah, Du Jianguo, James Small Azibah, Patrick Boateng Sarpong

Abstract


The effect of exchange rates movements and its associated volatility has remained a crucial issue in a small open economy like Ghana. The subject holds a central place in international financial and macroeconomic management and policy formulation. This has engendered a lot of researching on the pass-through effects of exchange rates. This study employs co-integration and error correction model to explore the pass-through effects of exchange rate changes to consumer price index for Ghana, covering the period January 2000 to March 2016. The study seeks to provide answers to numerous questions like the degree of exchange rate pass- through (ERPT) to consumer price, issues of asymmetry effects, the validity of purchasing power parity and exchange rates models. The empirical evidence suggests that, fluctuations in the exchange rate either affect inflation through direct changes in import prices or through aggregate demand, which is issued as part of changes in the relative price between foreign and domestic commodities. However, the low ERPT to consumer prices suggests that inflation is most likely affected by other factors than the exchange rate. Among the variables included in our model, consumer price inflation responds significantly to shocks in external price, interest rate, and shock to price itself. An increase (positive shock) in the foreign price variable results in significant increase in domestic prices implying that the country is exposed to global price shocks (imported inflation). Using variance decomposition test in the study, it demonstrates the importance of shocks within the imports and the consumer price themselves verse shocks from the exchange rate and other variables in the economy. The findings suggest that sound monetary policies and economic management environment should focus on achieving a stable exchange rate inflation since monetary policies do not affect the prices of commodities positively.


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