Interest Rate and Exchange Rate Volatility Spillovers: Multiscale Perspective of Monetary Policy Transmission in Ghana

Abstract

Ghana’s economy is characterised by acute exchange rate volatility alongside persistent and high consumer inflation. This places the economy among the sub-Saharan African countries with the highest inflation over the years. Therefore, we explore in-sample and out-of-sample macro-volatility spillovers to determine the effectiveness of monetary policy and also ascertain the relevance of the exchange rate in Ghana’s interest rate setting at both time and multiscale domains. The study reveals scale-dependent interconnectedness among the macro-variables as their causal linkages broadly intensify at the longer time-scale. We find the real policy rate and the exchange rate to be net transmitters of shocks, while inflation and output gaps are net receivers of shocks from the system. Output gap, however, is the largest net receiver of shocks from the system. The empirical findings generally buttress the prerequisite to uphold exchange rate stability in order to inure general macroeconomic stability in Ghana. In addition, the extent of spillover dynamics from policy interest rate to and from the targeted macro-variables (particularly output gap and inflation) appears to be moderate even in the long run, surmising less effective monetary policy transmission in Ghana.

Dynamics of Money Market Interest Rates in Ghana: Time‐Frequency Analysis of Volatility Spillovers

“…To the best of our knowledge, the extant literature offers no empirical evidence on the co-movements and (non)linear spillovers among money market interest rates in a multi-scale domain. A study that is close to the current work in terms of methodology is Akosah et al (2020). However, the latter study focused solely on the second phase of the interest rate transmission channel by analysing volatility spillovers among the policy interest rate, inflation, output and exchange rate in Ghana.…”

“…Number of studies (notably, Acheampong, 2005;Ghartey, 2005;Kovanen, 2011;CEPA, 2012;Fukac & Baldini, 2014;Akosah, 2015;Akosah et al, 2020;etc. ) have explored the effectiveness of monetary policy in Ghana via the interest rate transmission channel.…”

“…Using linear/nonlinear Granger non-causality test and the generalised forecast error variance decomposition (GFEVD) method, Akosah et al (2020) explored volatility spillovers among policy rate, exchange rate, inflation and output to determine the effectiveness and transmission of monetary policy to the real economic activities in Ghana. They also ascertain the relevance of the exchange rate in Ghana's interest rate setting at both time and multiscale domains.…”

“…Notwithstanding, the empirical findings of these researches including those documented by particularly for countries in the SSA region, are generally mixed. Besides, these studies (excluding Akosah et al, 2020) predominantly present linear and semi-parametric analysis at timedomain and hence, overlook possible nonlinear dynamics as well as offer virtually no information about the frequency at which policy interaction takes place. However, some recent empirical works have applied copula functions to explore nonlinear dependence and interrelationship between macroeconomic variables (notably, Patton, 2006Patton, , 2012Nguyen and Bhatti, 2012;Hammoudeh et al, 2014;Mensah and Alagidede, 2017;Mensah and Premaratne, 2017;etc).…”

“…Besides, our study offers complementary approaches, and hence, offers a more comprehensive analysis of connectedness and shock transmission. As aforementioned, although the methodology in this study is broadly akin to those applied by Akosah et al (2020), the current study still differs significantly. While the current paper focuses on the pass-through of policy interest rate to other money market interest rates (i.e.…”