The transmission of economic shocks: evidence from Ghana

Abstract

This study investigates possible time variation in the transmission of key macroeconomic shocks to Ghana’s economy, namely monetary policy, fiscal policy, and external shocks. In terms of external shocks, the study focuses on foreign monetary policy shocks proxied by the US federal funds rate, foreign demand shocks using real GDP growth rate of the OECD countries as a proxy, and crude oil price shocks. Data analysis is undertaken utilising the TVP-VAR-SV model, and using quarterly data for the period 1984q1-2018q4. In the case of monetary policy shocks, the study finds evidence of time variation with decreasing tendencies in the latter years, implying steady improvement in macroeconomic stability. The transmission mechanism is initially counterintuitive, but becomes more intuitive and in line with traditional theoretical predictions as macroeconomic reforms take hold. In the case of fiscal policy shocks, the empirical evidence points to more gradual shocks with the transmission mechanism exhibiting similar patterns as the monetary transmission mechanism – it is initially counterintuitive but increasingly conforms to traditional expectations over time. Fiscal expansion via government spending exerts a progressively positive impact on private consumption, implying that government expenditure shocks are decidedly Keynesian. This evidence points to the rising number of rule-of-thumb consumers in the Ghanaian population. In the face of positive tax shocks, the study discovers a switch from Ricardian behaviour to displaying characteristics of Keynesian agents. The three key external shocks exhibited time-varying tendencies with the volatilities decreasing and more stable in recent times. The reaction of domestic variables to the various time-varying shocks varied with the transmission mechanism and improved over time as macro stability increased on the back of profound reforms. In particular, an increase in the US federal funds rate was broadly damaging to Ghana’s economy whereas a positive foreign demand shock proved generally favourable. Over the last decade, the growth implications of a positive crude oil price shock have been positive, but coupled with inflation, depreciation and tight monetary policy. Broadly, macroeconomic policy and forecasting models will benefit from incorporating features of time variation, which will help minimise costly policy errors. Gradual stabilisation of inflationary shocks, accompanied by an enhanced communication strategy to help minimise supply side effects, and the reinvigoration of the manufacturing sector through the ISI strategy to provide sustainable jobs are also recommended.