Thesis Statement about Inflation

1 Background of the study

Macroeconomic stability is a fundamental macroeconomic policy objective of every country, whether developed or developing (Frimpong & Oteng-Abayie, 2010; Agalega & Acheampong, 2013). This has made the study of the relationship between inflation and economic growth of interest to economists for a long period of time (Khan, 2014). The primary objective of such studies has been to identify robust evidence of the sign of this relationship and its stability over time (Khan, 2014). Nonetheless, such theoretical and empirical studies have often yielded diverse conclusions regarding the direction of the impact of inflation on economic growth (Frimpong & Oteng-Abayie, 2010 ).

Key macroeconomic factors such as interest rate, exchange rate, and price stability (inflation rate) affect the economic performance of every nation, making price stability a major monetary policy objective in almost every country (Anidiobu, Okolie, & Oleka, 2018). Due to the vital role macroeconomic variables such as interest rates, inflation, and exchange rates play in the economic performance of a country, monetary and fiscal policies in Ghana have often aimed at sustaining high economic growth rates amidst low inflation or price stability. (Frimpong & Oteng-Abayie, 2010; Agalega & Acheampong, 2013). Although Ghana has been targeting a single-digit average inflation rate (Agalega & Acheampong, 2013), the country is still battling to overcome the persistent year-to-year increase in inflation, and also its causes and consequences (Anafo, Kweku, & Naatu, 2014). The inflation rate in Ghana had risen over the past few years and is still rising. In the month of September 2011, inflation in Ghana was 8.40% and in the month of November 2013, it had risen to 13.20%.

Zou et al. (2011) opine that inflation is a major cause of social and economic instability. Considered the most observed and tested economic variable theoretically and empirically (Farid et al, 2012), inflation is the major problem of most economies and exerts diverse influences on the economic growth of every country (Anafo, Kweku, & Naatu, 2014). Comment by Maison, Isaac: From Anafo, Kweku, & Naatu, 2014 Comment by Maison, Isaac: from Anafo, Kweku, & Naatu, 2014

Inflation, defined as the general increase in the level of prices of goods and services in an economy over a period of time, reduces the purchasing power of people, making it deleterious to economic growth (Anafo, Kweku, & Naatu, 2014). Thus, whereas Fischer (1993) concludes that inflation is not good for the longer-term growth of an economy, Barro (1996) opines that price stability is a central pillar of economic growth. ). The effects of inflation on economic growth in developing countries are thus of much interest (Gillman & Harris, 2009). However, theoretical and empirical studies on the inflation-economic growth nexus have been inconclusive and controversial. (Idris and Bakar, 2017; Majumder, 2016). While some posit a negative relationship (Fisher, 1993 and Barro, 1995), others conclude a positive relationship (Mallik and Chowdhury, 2001) with some unable to establish any relationship (Sidrauski, 1967). This has resulted in a knowledge gap regarding the relationship between inflation and economic growth. (Adusei, 2012). These diverse findings call for further research in the field. An answer to this question will therefore go a long way in guiding policymakers in choosing appropriate inflation targets to improve the macroeconomic management of Ghana’s economy (Frimpong & Oteng-Abayie, 2010).

2 Problem of the statement

This study is to determine the major macroeconomic causes of inflation and its effect on the economic growth of Ghana. Majumder (2016) opines that the question today is not only about the simple relationship between inflation and economic growth but also the level of inflation that can affect economic growth. Thus, recent empirical studies on inflation-growth nexus have sought to determine the threshold level above which inflation hurts economic growth (Adusei, 2012).). The question regarding the threshold level above which inflation harms the economy is thus empirically unanswered (Frimpong & Oteng-Abayie, 2010). There is however no consensus on the actual threshold level for Ghana (Ayisi, 2013).With most empirical studies in Ghana suggesting that inflation begins to hurt growth when it exceeds the single-digit threshold level (Adusei, 2012), monetary and fiscal policies have aimed at reducing inflation to single digits. (Ayisi, 2013). However, these studies have reported different threshold levels (Frimpong and Oteng-Abayie, 2010; Munir and Mansur, 2009; Hussain, 2005; Burdekin et al., 2004; Gillman et al. 2002; Khan and Senhadji, 2001; Ghosh and Phillips, 1998; Bruno and Easterly, 1998; Sarel, 1996; Fischer, 1993.

Although empirical results have posited non-linear effects of inflation on economic growth in developed countries, the effects of inflation on developing countries are less clear (Gillman & Harris, 2009). Also, cross-country panel studies have dominated existing empirical literature on the threshold effect of inflation on economic growth. Because factors pertaining to different countries are heterogeneous, country-specific studies need to be conducted to provide specific evidence relevant to the country under study (Frimpong & Oteng-Abayie, 2010 ). Comment by Ettandoh: the topic should be ‘the relationship between inflation and economic growth and the acceptable threshold that will positively affect economic growth

Finally, existing studies in Ghana have overly dwelt on the effects of inflation on the economy (Frimpong & Oteng-Abayie, 2010; Agalega & Acheampong, 2013; Adusei, 2012; Ayisi, 2013) without delving much into the causes of inflation in Ghana.

3. Objectives of the study

Comment by Ettandoh: objectives of the study: The relationship between inflation and economic growth (long run and short run)To determine the threshold level of inflation that hurts the economic growth of Ghana.

The main goal of the study is to examine the macroeconomic causes of inflation and its effects on Ghana’s economic growth. The study intends to achieve the following specific objectives:

1. To determine the major cause of inflation in Ghana.
2. To examine any long-run relationship between inflation and economic growth in Ghana.
3. To examine any short-run relationship between inflation and economic growth in Ghana.
4. To determine the threshold level of inflation that hurts economic growth in Ghana.

4 Hypothesis

Following the abovementioned objectives, the study will test the following hypotheses:

• HO4: There is a causal relationship between inflation and exchange rate, interest rate, government spending, and economic growth.
  • HA4: There is no causal relationship between inflation and exchange rate, interest rate, government spending, and economic growth.
• HO1: There is a significant long-run relationship between inflation and economic growth in Ghana.
  • HA1: There is no significant long-run relationship between inflation and economic growth in Ghana.
• HO2: There is a significant short-run relationship between inflation and economic growth in Ghana.
  • HA2: There is no significant short-run relationship between inflation and economic growth in Ghana.
• HO3: There is a threshold level beyond which inflation hurts economic growth in Ghana.
  • HA3: There is no threshold level beyond which inflation hurts economic growth in Ghana.

5 Significance of the Study

This research will benefit policymakers, academics, and other stakeholders like investors and economic/financial analysts. The study will examine the causes of inflation in Ghana. It will also assess the effects of inflation in Ghana and determine the threshold level beyond which inflation hurts Ghana’s economy. The question regarding the threshold level above which inflation harms the economy is empirically unanswered and an answer to this question will go a long way in guiding policymakers in choosing appropriate inflation targets to improve the macroeconomic management of Ghana’s economy (Frimpong & Oteng-Abayie, 2010). Thus, the study will assist policymakers in inflation targeting and offer them vital information needed to make inflation-targeting policies and predictions that will help Ghana achieve a desirable inflation rate needed to stimulate economic growth in Ghana. This is very important considering the efforts/resolves of the current Ghana government to curb inflation, achieve price stability, and sustained economic growth. Sowa (1994) opines that the macroeconomic conditions of Ghana are similar to that of most sub-Saharan African countries. Thus, the findings of this research will not only benefit Ghana’s policymakers but will also be of benefit to policymakers in other sub-Saharan African countries.

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To academia, this research will add to current knowledge on the effect of inflation on Ghana’s economy. While inflation remains a persistent problem in most developing countries (Barro, 1995), making the effects of inflation on economic growth in developing countries of much interest (Gillman & Harris, 2009), the effects of inflation on developing countries are less clear (Gillman & Harris, 2009). Theoretical and empirical studies on the inflation-economic growth nexus have been inconclusive and controversial (Idris and Bakar, 2017; Majumder, 2016) (Fisher, 1993 and Barro, 1995), (Mallik and Chowdhury, 2001) (Sidrauski, 1967). These diverse findings call for further research in the field. Comment by Maison, Isaac: from (Majumder, 2016).

Also, Majumder (2016) opines that the question today is not only about the simple relationship between inflation and economic growth but also the level of inflation that can affect economic growth. while recent empirical studies on inflation-growth nexus have sought to determine the threshold level above which inflation hurts economic growth (Adusei, 2012), there is no consensus on the actual threshold level for Ghana (Ayisi, 2013; Frimpong and Oteng-Abayie, 2010). The question regarding the threshold level above which inflation harms the economy is thus empirically unanswered (Frimpong & Oteng-Abayie, 2010) and this paper will contribute to answering that question.

6 Scope and Limitations of the Study

The study will use GDP growth as a proxy for economic growth, in line with extant research (Oteng et al., 2016; Alhasan and Fiador, 2014). Although, economic growth has been conventionally measured as the percentage change in real gross domestic product (Oteng et al., 2016), Ivković (2016) argues that the measurement of GDP is affected by black market/informal transactions and poor record keeping. The GDP for Ghana will thus be affected by these factors. It is hoped that improved record keeping in the future and digitization of the Ghanaian economy will yield improved GDP measurements.

The study also uses inflation as an independent variable. Although inflation is available in monthly, quarterly, and yearly frequencies, this work will be restricted to the use of yearly data because it includes control variables such as FDI and labor, which are available only in yearly frequency. The use of monthly or quarterly data is thus restricted in this study. Future studies can explore other variables that will make the use of quarterly or monthly data possible.

7 Methodology

The study will employ the VAR/VECM techniques and use annual time series data from 1975 to 2018.

The study will use economic growth as the dependent variable while inflation will be the dependent variable. Labor, capital, trade openness, exchange rate, government expenditure, interest rate, and foreign direct investment will be used as control variables. Extant research has used variables such as real GDP growth as a proxy for economic growth (Oteng et al., 2016; Alhasan and Fiador, 2014). In line with these extant works, economic growth will be computed as, where Y represents economic growth, and is the real GDP at the time (t) while in the prior year’s GDP.

The first step will be to test the order of integration of the variables and to ensure that the variables are of order I(1). After the unit root test, the Johansen cointegration test will be performed to ensure that the variables move in a long-run relationship. The inflation rate will then be normalized in a vector autoregressive (VAR) model to determine the short-run and long-run causes of inflation. The VAR variance decomposition will be employed to determine the proportion of the movements in inflation rate that are due to “own” shocks, and the changes in inflation emanating from shocks to the other variables.

The VECM will then be used to determine the short-run and long-run effects of inflation on economic growth in Ghana. Following Begum, et. al (2015), Mwinlaaru and Ofori (2017), and Frimpong and Oteng-Abayie (2006), this work will adopt the Solow growth model/Cobb-Douglas production function, which is generally stated as: where Y represents economic or GDP growth, K represents capital, and A represents total factor productivity (the GDP growth attributable to other factors of production aside capital and labor). The following explanatory variables are added to derive the growth function: trade openness, exchange rate, government spending, interest rate, and foreign direct investment. The nonlinear effects of inflation on economic growth are considered by including the quadratic form of inflation and the basic equation is stated below:

Where Y represents economic/GDP growth, INF represents inflation, INFS is the quadratic form of inflation, L is labor, K represents capital, TRP is trade openness, GEX is government spending, ER represents exchange rate, FDI is foreign direct investment, INT is the nominal interest rate. is a constant, is the coefficient of the respective variables, is the time period while is the error term,

Following Begum et al. (2015), the Lind and Mehlum (2010) U test will be used to determine the threshold level beyond which inflation hurts the Ghanaian economy. The Lind-Mehlum U test will also determine whether the relationship between inflation and economic growth is u-shaped or inverse u-shaped.

8 Organisation of the study

This study is organized into five chapters. Chapter one, the introductory chapter, will discuss the background of the study, state the research problem and objectives, develop the hypothesis, and give the scope and limitations of the study. Chapter two will entail the theoretical and empirical literature review on the topic. The theoretical literature review will present the theories on inflation-economic growth nexus while the empirical literature review will discuss the empirical findings of other works on the topic. The third chapter will present the methodology adopted for the study. It will present the models for the study and discuss the detailed research methodology for the study. Chapter four will present the results of the study and analyze the results. The final chapter will present a summary of the work, state the main research findings, draw conclusions, and make relevant recommendations. It will also make suggestions for further studies.