NO.

28 IEA MONOGRAPH

Assessment of
Inflation Trends,
Management
and Macroeconomic
Effects in Ghana
THE INSTITUTE OF ECONOMIC AFFAIRS
IEA
Ghana A Public Policy Institute
 Assessment of
Inflation Trends,
Management
and Macroeconomic
Effects in Ghana
1
by DR. J. K. KWAKYE

1
Dr. Kwakye worked with the Bank of Ghana for twenty years until 2000, predominantly in the Research Department.
For the following ten years, he worked at the International Monetary Fund in Washington, D.C., as Advisor to the
Executive Director Responsible for Ghana. Dr. Kwakye is currently a Senior Fellow at the Institute of Economic Affairs.
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Preface

G
hana has experienced high inflation over a long
period of time. Over the past thirty years,
monetization of fiscal deficits and cyclical food
deficits have been the principal drivers of inflation. Achieving
sustained disinflation therefore depends on addressing
these factors on a durable basis.
In this paper, the author notes that, inflation management
under the previous monetary targeting (MT) framework was
ineffective because of the intractability of the underlying
causes. The move to inflation targeting (IT) in 2007 did not
help matters, mainly because of the stubborness of the
underlying causes as well as the absence of the key IT policy
and structural conditions.
The author states that, fiscal austerity has helped recent
disinflation, but could also have contributed to a slowdown
in the economy, especially in 2009. In his view, low, stable
inflation is beneficial to growth and employment in the long-
run, although there could be short-term costs to rapid
disinflation. This assertion is supported by both theoretical
and empirical literature, including Ghana’s own experience.
He concludes by noting that, oil production will be
potentially the biggest influence on future inflation, given
expected boost in government expenditure and general
aggregate demand. In his view, achieving the low single-digit
inflation envisaged over the medium-term would entail
exceedingly tight monetary policy, which could in turn put
brakes on economic activity.

We hope you find this publication useful.

Jean Mensa
Executive Director
The Institute of Economic Affairs
 1

1.0 Introduction

Ghana has experienced persistently high rates of inflation for several decades.
This suggests that either the causes have been intractable, or inflation
management has been ineffective, or both. Since July 2009, however, inflation
has fallen consistently and by a significant margin, with the oft-elusive single-
2
digit level being reached since June 2010. With government efforts to reduce
the fiscal deficit that reached a record high in 2008, and a significant slowdown
of the economy in 2009—which could also have been affected by the global
economic slowdown—some people have suggested that the rate of disinflation,
which they contend to be driven by fiscal austerity or retrenchment, might be
too rapid and could have costly output and employment losses down the road.
The purpose of this paper is to throw some light on Ghana's experience with
inflation in the past and in the recent period. The paper also looks into the
question of whether there are potential output and employment costs to
achieving very fast disinflation. The paper is structured as follows: Following
this introduction, Section 2 examines inflation trends and causes during the
past three decades. This is followed in Section 3 by an assessment of inflation
management from the monetary targeting era to the current inflation targeting
framework. Section 4 examines the inflation-output link and attempts to
address the question of whether there might be permanent output and
employment costs to the current disinflation process. Section 5 looks at the
sustainability of the current progress in disinflation, especially with the coming
on-stream of oil production in the country. The last section concludes the paper.

2.0 Inflation Trends and Causes

2.1 The Period 1979-2009

During the thirty year period, 1979-2009, Ghana experienced very high rates of
inflation. The inflation rates were invariably in the double-digit territory and
averaged 32 percent per annum—very high rates by any standard.

Table 1: Inflation, 1979-2009

Year Inflation (Year-on-Year) (%)
1979 18.3
1980 87.8

2
This is not the first time single-digit inflation has been achieved in Ghana. Single-digit inflation was achieved in
the past, albeit for brief periods and could not be sustained.
2 The Institute of Economic Affairs

1981 100.4
1982 16.7
1983 142.4
1984 6.0
1985 19.5
1986 33.3
1987 34.2
1988 26.6
1989 30.5
1990 35.9
1991 10.3
1992 13.3
1993 27.7
1994 34.2
1995 70.8
1996 32.7
1997 20.8
1998 15.7
1999 13.8
2000 40.5
2001 21.3
2002 15.2
2003 23.6
2004 11.8
2005 14.8
2006 10.9
2007 12.8
2008 18.1
2009 16.0
AVG 31.5
Source: Ghana Statistical Service

Chart 1: Inflation, 1979-2009

Inflation (Year-on
Year)(%)
 3

Most of the empirical literature attributes Ghana's high inflation to demand

pressures emanating from monetization of fiscal deficits. The decision by
Ghana after independence to set up its own central bank to conduct
independent monetary policy sowed the seeds for future high inflation. Over the
years, the central bank became an important source of financing for
governments' budgets—a classical ingredient for high inflation. It is not by
chance that Ghana has had much higher rates of inflation compared to its peers
who chose to conduct their monetary policy in the context of monetary unions
that limit monetization of fiscal deficits.

Table 2: Inflation and Money Supply Growth, 1979-2009

Year Inflation (Year-on Year)(%) Money Supply Growth (%)

1979: Dec 18.3 10.9
1980 87.8 30.1
1981 100.4 63.0
1982 16.7 21.2
1983 142.4 52.6
1984 6.0 41.9
1985 19.5 63.2
1986 33.3 48.6
1987 34.2 30.3
1988 26.6 44.9
1989 30.5 51.8
1990 35.9 17.1
1991 10.3 5.7
1992 13.3 57.4
1993 27.7 32.2
1994 34.2 45.4
1995 70.8 33.4
1996 32.7 31.3
1997 20.8 45.3
1998 15.7 22.3
1999 13.8 39.9
2000 40.5 46.5
2001 21.3 15.8
2002 15.2 60.5
2003 23.6 38.4
2004 11.8 28.2
 4 The Institute of Economic Affairs

2005 14.8 6.3

2006 10.9 35.1
2007 12.8 39.9
2008 18.1 29.7
2009 14.8 9.4
Source: Ghana Statistical Service and Bank of Ghana.

Chart 2: Inflation and Money Supply Growth, 1979-2009

This is not to say, however, that Ghana's inflation has been entirely a monetary
phenomenon. Other “residual” factors have been recognized in the literature as
emanating from the “real” or “supply” side of the economy. Among these, food
inflation has been cited as contributing to the high aggregate inflation in
Ghana.3 In fact, the real-side effects appear to have been more prominent in the
pre-1983 period. The inflation-monetary growth plot in Chart 2 shows much
higher amplitudes for inflation than for monetary growth for that period,
indicating that inflation was influenced by other important factors beyond
monetary growth. After substantial deregulation of the economy from 1983 in
the context of the Economic Recovery Program (ERP) and the successive
Structural Adjustment Programs (SAPs), cost pressures have become an
important factor in influencing inflation. Among these are pressures emanating
from rising energy and utility prices and exchange rate depreciation. As inflation
became entrenched, expectations also became embedded in wages, exchange
rates, interest rates and the prices of goods and services, further fuelling
inflation.

3
See Kwakye, 1981, and Sowa and Kwakye, 1993, among others.
 5

2.1 The Recent Period, January 2009-August 2010

Since January 2009, inflation has fallen from around 20 percent to 9.4 percent
in August 2010. Some people have attributed the recent disinflation to fiscal
austerity or retrenchment, although the authorities deny this. But what do the
facts show?

Table 3: Inflation, Jan. 2009-August 2010

Period Inflation (Year-on-Year)
2009: Jan 19.9
Feb 20.3
Mar 20.5
Apr 20.6
May 20.1
Jun 20.7
Jul 20.5
Aug 19.7
Sep 18.4
Oct 18.0
Nov 16.9
Dec 16.0
2010:Jan 14.8
Feb 14.2
Mar 13.3
Apr 11.7
May 10.7
Jun 9.5
Jul 9.5
Aug 9.4
Source: Ghana Statistical Service and Bank of Ghana

Chart 3: Inflation, Jan. 2009-Aug. 2010

Inflation (Year-on
Year)(%)
 6 The Institute of Economic Affairs

Table 4: Government Revenue and Expenditure (Percent of Non-oil GDP)

Year Domestic Aggregate Recurrent Capital
Revenue Expenditure Expenditure Expenditure
2007 22.70 37.30 23.00 14.40
2008 22.80 41.00 25.40 15.70
2009 22.50 34.20 22.30 11.90
2010 25.90 38.10 27.30 10.80
2011 29.40 35.80 25.00 10.80
2012 29.30 33.50 23.70 9.80
2013 31.90 34.80 22.90 11.90
Source: IMF Staff Report on Ghana's First and Second ECF Reviews,
May 17, 2010. 2010-2013 figures are estimates.

Oil production is presumed to start in 2011-Q1.

Chart 4: Government Revenue and Expenditure,2007-2013

Government expenditure as a ratio of GDP in fact contracted in 2009 by 6.8

percentage points from 41.0 percent to 34.2 percent, even as revenue remained
at about the same level. (See Table 4). The reduction in expenditure reflected in
both recurrent and capital expenditure, which decreased by 3.10 and 3.80
percentage points each. Notably, the reduction in government expenditure was
accompanied by net accumulation of domestic arrears.
While some repayments were made, more arrears were accumulated such that
at the end of 2009, total outstanding payment arrears amounted to GH¢1,429
million, compared with GH¢1,131 million at end of 2008, representing a net
 7

increase of GH¢298 million or 26 percent. (See Table 5). In 2010, the stock of
arrears is projected to fall by GH¢110 million or 7.7 percent to GH¢1,319
million, which will still be above the end-2008 level. The reduction in
government expenditure reduced the flow of money into the economy, with
(narrow) money supply growing by a mere 9.4 percent in 2009 compared with
29.7 percent in 2008. Reduced monetary growth meant reduced aggregate
demand growth that contributed to dampen inflation pressures. Given the
dominance of the public sector in the Ghanaian economy in terms of the
resources it commands and the employment it provides, reduction in
government expenditure can greatly affect spending—including spending by
government employees, road contractors, suppliers of government goods and
services, municipalities, statutory funds and subvented organizations. As we
have noted above, reduction in government expenditure reflected in both the
recurrent and capital components, which should have widespread
consequences.

Table 5: Stock of Domestic Payment Arrears (GH¢Million)

Year Repayments Accumulation End-Period Stock

2007 n.a n.a n.a
2008 n.a n.a 1,131
2009 627 924 1,429
2010 223 113 1,319
2011 740 150 729
2012 729 166 166
Source: IMF Staff Report on Ghana's First and Second ECF Reviews, May 17, 2010.

Apart from the dampening impact of reduced government spending on inflation,

the effect of low food inflation on recent overall inflation has been particularly
significant and should be duly recognized. In fact, were it not for this effect, we
would not be having single-digit headline inflation by now. This is because while
food inflation reached single digit as far back as January 2010, non-food
inflation has remained in double digits. (See Table 6 and Chart 5). That
indicator—which is one measure of core inflation—should be the proper
judgment on the effectiveness of monetary policy.

In fact, non-food inflation rose in July and further in August, which could be a
turning point in its recent decline, given the potential impact of higher utility
prices and the advent of the Single-Spine Salary Structure. Pressures on
government spending, including towards clearing domestic arrears, also pose a
risk to inflation going forward.4 If the rise in non-food inflation should persist,

4
In fact, government expenditure is projected to increase by as much as 3.9 percentage points in 2010.
(See Table 4).
 8 The Institute of Economic Affairs

we would not be surprised to see the MPC halt or even reverse its recent policy-
easing bias.

Table 6: Inflation, Jan. 2009-Aug 2010: Combined, Food, Non-Food

Period Combined Inflation Food Inflation Non-food Inflation
2009: Jan 19.9 19.4 20.2
Feb 20.3 19.0 21.3
Mar 20.5 18.5 22.0
Apr 20.6 19.3 21.5
May 20.1 17.2 22.2
Jun 20.7 15.5 24.7
Jul 20.5 15.2 24.5
Aug 19.7 14.8 23.3
Sep 18.4 12.8 22.4
Oct 18.0 13.5 21.2
Nov 16.9 12.4 20.1
Dec 16.0 11.8 18.8
2010: Jan 14.8 9.1 18.8
Feb 14.2 8.2 18.5
Mar 13.3 7.4 17.6
Apr 11.7 5.8 15.8
May 10.7 4.7 15.0
Jun 9.5 6.1 11.9
Jul 9.5 5.8 12.0
Aug 9.4 5.3 12.3
Source: Ghana Statistical Service

Chart 5: Inflation, Jan. 2009-Aug. 2010: Combined; Food, Non-Food

 9
The recent decline in inflation has also been helped by a relatively stable
exchange rate, which in turn must have been aided by the reduced government
spending and aggregate demand. The year 2009 also appears to have coincided
with declining oil prices and stable utility prices as well as low world inflation
due to the global recession. All these factors must have aided the decline in
domestic inflation. In fact, in the more recent period, Jan-Aug 2010, while
monetary growth rates have been high and rising, inflation has been on a
declining path, again highlighting the dominant influence of declining food
inflation (See Table 7 and Chart 6).

Table 7: Inflation and Money Supply Growth, Jan.-Aug, 2010

Year Inflation (Year-on Year)(%) Money Supply Growth Rate (%)
2010: Jan 16.0 18.8
Feb 14.2 22.3
Mar 13.3 28.8
Apr 11.7 25.6
May 10.7 27.0
Jun 9.5 26.6
Jul 9.5 29.8
Aug 9.4 35.8

Chart 6: Inflation and Money Supply Growth, Jan.-Aug. 2010

 10 The Institute of Economic Affairs

3.0 Inflation Management

Prior to 2007, monetary policy was conducted under a monetary targeting (MT)
framework. Under this framework, money supply was controlled as an
intermediate variable, using largely quantity-based Open Market Operations as
the operating instrument, in order to achieve the ultimate target, inflation.
There was limited success in controlling inflation given the effect of large-scale
deficit financing on monetary growth coupled with supply shocks and other
cost-push factors over which the central bank had little or no control.
Meanwhile, the relationship between money supply and inflation weakened over
time, a manifestation usually attendant to financial and other structural
changes in the economy.
In 2007, the monetary authorities decided to shift from monetary-targeting (MT)
to inflation- targeting (IT), which directly targets inflation without using money
supply as a route. The key operating instrument has been the benchmark Policy
Rate (PR) by which the central bank signals a change in the cost of credit. The IT
framework has been adopted by a number of advanced economies and a handful
of developing economies, in most cases as a natural progression from monetary
targeting. IT seeks to enhance transparency and accountability in inflation
management. To be effective, IT requires certain policy and structural
conditions. The key policy conditions are fiscal discipline and exchange rate
flexibility, both of which facilitate monetary policy conducted mainly via interest
rates. A key structural requirement for successful IT is a financial sector that is
sufficiently developed to be able to support effective transmission of monetary
policy through interest rates to inflation and the real economy. Also important is
autonomy of the central bank to conduct monetary policy freely. Additionally,
effective IT requires adequate and reliable data and a robust and comprehensive
forecasting model.
The natural question to ask is how conditions in Ghana measure up against
these requirements.
On the policy side, fiscal dominance has remained a feature of the Ghanaian
economy. This puts pressure on monetary policy, which has to counter the
adverse effects, including pressures on the prices of goods and the exchange
rate.
Regarding exchange rate policy, despite the de jure adoption of a “flexible
regime” as far back as 1984, the exchange rate cannot be said to have been left
fully to the interplay of market forces. Official sales of foreign exchange to meet
demand for imports and other payments cannot always be separated from
interventions ostensibly aimed at “smoothing short-term fluctuations in the
exchange rate,” to use the official parlance. Demand pressures emanating from
expansionary macroeconomic policies and occasional shortfalls in foreign
exchange supply have, however, led to persistent exchange rate depreciation. In
 11
the past year, however, the exchange rate has been fairly stable, ostensibly due
to reduced fiscal pressures and low foreign exchange demand from a slowing
economy. The benefit of a flexible exchange rate is that it helps to absorb shocks
and take some of the pressure off monetary policy, which otherwise would have
to be tightened through interest rate increases.
On the structural side, despite the fast growth of the financial sector in the past
few years, financial intermediation and financial depth remain low, implying
that transmission of monetary policy via interest rates remains weak. On the
other hand, while the autonomy of the central bank is guaranteed de jure under
its Charter, the exercise of this autonomy, de facto, has been tepid in the face of
fiscal dominance in the economy. On the forecasting framework, the timeliness
and reliability of data may not be the best. Further, it is not certain how robust
and comprehensive the forecasting model is. In IT, a future forecast of inflation
is usually made and policy action initiated today to ensure that the target will be
reached, given lags in the impact of policy. In other words, the approach is one of
forward-looking. We want to believe that the Monetary Policy Committee (MPC)
adopts a similar approach. However, the way that the MPC seems to place
considerable emphasis on past inflation developments as the basis for its
current policy actions, would appear to suggest a kind of backward-looking
bias. That is, instead of leading inflation, the MPC may be following it. More
specifically, in recent months that the MPC's Policy Rate has been consistently
reduced, this has been justified in terms of falling inflation. But, we want to
believe that the policy easing would ensure the achievement of future inflation
targets.
Another important issue in inflation management is the appropriateness of
monetary policy stance as signaled by the PR. A relevant measure of this stance
is the real PR, i.e. the nominal PR discounted for inflation.

Table 8: Real Policy Rate, Jun 2009-Jun 2010

Period Real Policy Rate
2009: Jun -2.24
Jul -2.00
Aug -1.15
Sep 0.13
Oct 0.46
Nov 1.08
Dec 2.03
2010: Jan 3.22
Feb 1.77
Mar 2.68
Apr 3.34
May 4.32
Jun 5.48
Jun'09-Jun'10 change 7.72
 12 The Institute of Economic Affairs

Chart 7a: Real Policy Rate, Jun 2009-Jun 2010

Chart 7b: Real Policy Rate, Jun 2009-Jun 2010

As Table 8 and Charts 7a and 7b show, the real PR was negative between June
and August 2009, before turning positive thereafter. The negative or low positive
real PR during June-Oct 2009 would suggest that monetary policy was not
sufficiently tight during that period. Meanwhile, recent MPC communiqués
indicate that the monetary authorities have been “easing policy” from October
2009—consistent with falling inflation—by reducing the PR. Ironically, the fact
that the real PR has been increasing seems to suggest to us rather a process of
 13
“policy tightening” in the real sense. Our inference from all this is that, on the
one hand, the monetary authorities did not seem to have had in place a PR that
was sufficiently high in the earlier period when it was needed to stem inflation.
On the other hand, in the latter period, the authorities might have been
tightening policy in a real sense rather than easing it, contrary to the official
pronouncements. The two results appear to suggest some kind of instrument-
goal inconsistencies.
Meanwhile, we know that the authorities' inflation target has been consistently
exceeded, sometimes by wide margins. Because of these shortcomings, some,
including the IMF, would prefer to describe Ghana's IT as “IT-lite” rather than a
“full-fledged IT.” It has indeed been suggested that the authorities intensify their
efforts to improve the critical policy and structural conditions to enhance the
effectiveness of the framework. As the IMF and others have also suggested, it
would probably be best, in the interest of monetary policy credibility, for the
authorities to channel their efforts, in the mean time, towards providing their
best “estimate” of inflation rather than trying to achieve what appears to be an
ever-elusive target. When conditions permit, the inflation estimates could be
transformed into concrete targets. There is some comfort in that the official
inflation target for 2010 might be achieved. But whether this year's success
could be replicated in the succeeding years is the key question, which we
examine in Section 5.

4.0 The Macroeconomic Effects of Inflation

and Disinflation

4.1 The General Literature

The preponderance of the literature suggests that macroeconomic stability is
more favorable to economic growth than macroeconomic instability. This is
because macroeconomic stability is considered to be more conducive to
investment. The relevant time frame here, however, is the long run. While there
must have been cases where macroeconomic instability has been associated
with growth, ostensibly because high inflation may temporarily make
businesses profitable and, therefore, lead to increased investment, growth
tends to be volatile in a macroeconomically-unstable environment.
Macroeconomic stabilization policies may also lead to loss of output in the short
run, but over the long run, it is considered to be beneficial to growth and
employment. While the superior economic growth performance of South East
Asian countries was achieved through different policy models, one feature
common to them was the maintenance of macroeconomic stability. The
economies of their peers in Latin America that were characterized by
macroeconomic instability, on the other hand, achieved relatively erratic
growth.
 14 The Institute of Economic Affairs

Indeed, the adverse macroeconomic effects of high inflation are well

documented. Because it is perceived to increase uncertainty in business
planning, high inflation is considered to inhibit investment and therefore
economic growth. High inflation erodes the purchasing power of the middle
class and fixed-income earners who may become lethargic, disillusioned and
less productive. High inflation undermines the incentive to save and to work,
and breeds speculation, rentseeking and corruption, all of which are inimical to
economic growth. That said, it has been recognized that high inflation could
lead to higher investment and production to the extent that it might increase
profit margins for businesses. But such desirable effects are regarded as being
only temporary and could be eroded if high inflation is sustained over a longer
period of time when the adverse effects become overriding.
The adverse effects of low inflation are less well-documented. Low inflation may
result in output and employment losses, especially if it is achieved through
rapid and excessive compression of expenditure. By reducing profit margins for
businesses, low inflation may also lead to lower production and growth. But,
just like the potential benefits of high inflation, the adverse effects of low
inflation are regarded as temporary, with overriding potential long-term
benefits.

4.2 The Ghanaian Experience

Over the past year or so, Ghana has achieved a fast rate of disinflation, with
inflation reaching single digit during June-August 2010. In 2009, the budget
deficit was reduced by 4 percentage points, inflation was reduced by 3.3
percentage points, and real GDP growth fell by 3.1 percentage points. Some
commentators have tried to link directly the loss in real GDP growth—and,
possibly, jobs as well—to the reduction in the deficit and inflation.5

To the extent that the reduction in inflation in 2009 was accompanied by a

reduction in government expenditure, it could have contributed to the decline in
output and possibly in employment as well, although hard figures on
employment are difficult to come by. As we have indicated in Section 2.2 above,
the reduction in government expenditure in 2009 was reflected in both
recurrent and capital expenditure, which could have had a dampening effect on
private domestic consumption, investment and economic activity. We have to
recognize, however, that the demand for Ghana's exports also weakened due to
the global economic downturn, while remittances, Foreign Direct Investment
(FDI), and Overseas Development Assistance (ODA), and other foreign inflows
into the country slowed, dampening consumption, investment, and economic
activity. Several factors, therefore, contributed to the reduction in growth in
2009.

5
See CEPA's Report on the State of the Ghanaian Economy in 2009
 15
Whether continued disinflation could have permanent output and employment
costs, however, is uncertain, especially because we seem to have entered a
territory that has not been charted before in our history, i.e. bringing inflation
down so quickly to such low levels. The historical evidence from Ghana's past
would seem to suggest that periods of higher and more unstable inflation, such
as 1979-1990, were associated with lower and more volatile growth than
periods of lower and more stable inflation, such as 1991-2009. As Table 10
shows, the 1979-1990 period experienced average inflation of 46.0 percent with
a standard deviation of 41.5 and average real GDP growth of 1.7 percent with
standard deviation of 4.8 percent. Comparatively, the 1991-2009 period
experienced average inflation of 22.3 percent with a standard deviation of 14.6
percent and average real GDP growth of 4.8 percent with a standard of deviation
of 1.0 percent. Clearly, the more macroeconomically-stable period, 1991-2009,
achieved better growth performance.

Table 9: Inflation and Real GDP Growth, 1979-2009

Year Inflation (Year-on Year)(%) GDP Growth Rate (%)
1979 18.3 -3.8
1980 87.8 -0.2
1981 100.4 -3.2
1982 16.7 -5.9
1983 142.4 -4.1
1984 6.0 8.6
1985 19.5 5.1
1986 33.3 5.2
1987 34.2 4.8
1988 26.6 5.6
1989 30.5 5.1
1990 35.9 3.3
1991 10.3 5.3
1992 13.3 3.9
1993 27.7 5.0
1994 34.2 3.3
1995 70.8 4.0
1996 32.7 4.6
1997 20.8 4.2
1998 15.7 4.7
1999 13.8 4.4
2000 40.5 3.7
2001 21.3 4.2
2002 15.2 4.5
16 The Institute of Economic Affairs

2003 23.6 5.2

2004 11.8 5.6
2005 14.8 5.9
2006 10.9 6.4
2007 12.8 5.7
2008 18.1 7.2
2009 16.0 4.1

AVG 31.4 3.6

Chart 8: Inflation, 1979-2009

Chart 9: Real GDP Growth: 1979-2009

 17

Chart 10: Inflation and Real GDP Growth, 1979-2009

Table 10 a: Inflation and Real GDP Growth, 1979-1990

Year Inflation (Year-on Year)(%) GDP Growth Rate (%)
1979 18.3 -3.8
1980 87.8 -0.2
1981 100.4 -3.2
1982 16.7 -5.9
1983 142.4 -4.1
1984 6.0 8.6
1985 19.5 5.1
1986 33.3 5.2
1987 34.2 4.8
1988 26.6 5.6
1989 30.5 5.1
1990 35.9 3.3

AVG 46.0 1.7

STDEV 41.5 4.8

Table 10 b: Inflation and Real GDP Growth,1991-2009

Year Inflation (Year-on Year)(%) GDP Growth Rate (%)
1991 10.3 5.3
1992 13.3 3.9
1993 27.7 5.0
1994 34.2 3.3
1995 70.8 4.0
1996 32.7 4.6
1997 20.8 4.2
 18 The Institute of Economic Affairs

Ghana's past experience demonstrates that there is a positive association

between macroeconomic stability and growth over the long term. This is not to
deny, however, that there could be short-term costs to disinflation, especially if
it is carried out rapidly and if it involves significant contraction of government
expenditure and aggregate demand. As we have noted, inflation has been
brought down recently to hitherto-uncharted territory and has been associated
with austerity measures. Therefore, the disinflation could have contributed to
the reduction in growth in 2009. Low single-digit inflation is being targeted over
the medium-term horizon, despite the fact that government expenditure is
projected to rise, with a further boost from oil revenue. The expected boost in
government expenditure and in private demand will put pressure on inflation. If
the low single-digit inflation targets are to be achieved, monetary policy will
have to be extremely tight. Already the Governor of the Bank of Ghana has
signaled the intention of the Bank to use its entire monetary policy arsenal to
mitigate the potential inflationary impact of oil production and the Single Spine
Salary Structure, among other pressures. That arsenal could involve interest
rate hikes and currency appreciation, which could blunt the higher growth
expected from expansionary fiscal policy.

5.0 Likely Course of Future Inflation

The greatest impact on future inflation is likely to emanate from oil production.
In theory, oil production puts upward pressure on prices through the extra
demand generated from the revenue that may not likely be matched by supply of
goods and services because of production and supply constraints. The greatest
source of demand pressure will be spending by government as the principal
beneficiary of the revenue. The conduct of fiscal policy in the oil era will therefore
be critical for the future course of inflation. A more aggressive fiscal policy
geared to delivering an “oil dividend” to the population could put enormous
pressure on prices. Oil revenue would certainly allow domestic output and the
supply of imported goods to be increased, which would help dampen inflation
pressure. Oil production is also likely to result in exchange rate appreciation as
more foreign exchange becomes available to the economy. This would dampen
the impact of import prices on domestic inflation. On the other hand, as
recovery of the world economy takes hold, there is bound to be an uptick in
global inflation, which would affect domestic prices through imports.
Inflation would also be affected by some cost pressures. Utility tariffs are likely
to be increased periodically given the persisting gaps between providers' costs
and tariffs. This would put pressure on inflation.6 Another potential source of

6
Of course, there is considerable room for the utility companies to improve their efficiency and reduce their costs
and thereby ease the perennial pressure on tariffs.
 19

1998 15.7 4.7

1999 13.8 4.4
2000 40.5 3.7
2001 21.3 4.2
2002 15.2 4.5
2003 23.6 5.2
2004 11.8 5.6
2005 14.8 5.9
2006 10.9 6.4
2007 12.8 5.7
2008 18.1 7.2
2009 16.0 4.1

AVG 22.3 4.8

STDEV 14.6 1.0

inflation pressure would be the Single-Spine Salary Structure whose effect on

public sector pay is likely to spill over into the private sector. This will have both
cost and demand effects on inflation, the former from increased costs to
employers and the latter from increased incomes of employees. Food inflation
has long had a significant influence on headline inflation, given its dominant
weight in the CPI. It is difficult to predict the future course of food inflation given
the uncertainties in food production and unpredictability of related shocks. But,
unless significant improvements occur in food production, storage and
marketing, food inflation will continue to feature prominently in overall
inflation.

6.0 Conclusion
Ghana has been exceptionally prone to high rates of inflation, which could be
attributed to the intractability of the causes, or ineffectiveness of inflation
management, or both. Demand, driven by monetization of fiscal deficits has
been a major cause of inflation in Ghana. Real or supply side factors have also
contributed to Ghana's high rates of inflation, dominated by cyclical food
inflation. Following the extensive deregulation of the economy since 1983, cost
pressures emanating from rising petroleum and utility prices and exchange rate
depreciation have played an increasing role in the inflationary process. As
inflation became entrenched, expectations became embedded in wages,
exchange rates, interest rates, and general prices, further fuelling inflation. We
believe that the two critical requirements for sustaining low inflation in Ghana
are to purge the economy of “fiscal dominance” and increase production of food
and ensure its availability all year round.
Prior to 2007, monetary policy was conducted under a monetary targeting
framework, whereby money supply was used as an intermediate path to
targeting inflation. In the face of large-scale deficit financing, monetary policy
was ineffective in achieving the inflation targets. Monetary policy was further
 20 The Institute of Economic Affairs

rendered more ineffective by the weakening of the link between money supply
and inflation with financial and other structural changes in the economy. In
2007, the Bank of Ghana (BoG) adopted an IT framework that involves targeting
inflation directly without using a monetary aggregate as an intermediate
variable. To be effective however, it requires certain structural and policy
conditions, including a sufficiently developed financial system, central bank
autonomy, fiscal discipline and a flexible exchange rate regime. Further, there
should be adequate and reliable data and a robust and comprehensive
forecasting model. Ghana would appear to fall short in all these critical
requirements. It is no wonder therefore that the BoG has continually missed its
inflation targets, often by very wide margins. In that case, it is probably right to
describe Ghana's IT as “IT-lite” rather than a full-fledged IT. In the meantime,
the BoG's efforts could be channeled into providing its best forecast of inflation
rather than aiming to achieve an ever-elusive point- or range-target, until
conditions permit migration to a full-fledged IT.
In the past year, inflation has fallen consistently, reaching the oft-elusive single
digit level since June 2010. In 2009, government expenditure declined in the
effort to reduce the fiscal deficit that reached a record high in 2008. At the same
time, the economy significantly slowed down and, while this occurred amid a
slowdown of the global economy, some people have attributed it to the apparent
fiscal austerity and too rapid disinflation. This school of thought has argued
that there have been costly output and employment losses as a result of the
economic retrenchment policies. The authorities have, however, rejected this
assertion, arguing that government expenditure has been on course and that
there has not been any attempt to “orchestrate” disinflation through fiscal
retrenchment. Higher and more unstable inflation led to lower and more
unstable growth in Ghana during 1979-90, whereas lower and more stable
inflation led to higher and more stable growth during 1991-2009. This evidence
seems to support the view that low and stable inflation is more beneficial to
economic growth at least in the long run. Low single-digit inflation is being
targeted over the medium-term horizon. The expected boost in government
expenditure and in private demand from oil revenue and the Single Spine Salary
Structure respectively—will put pressure on inflation. If the low single-digit
inflation targets are to be achieved, monetary policy will have to be extremely
tight—including through high interest rate and currency appreciation—which
could dampen the projected higher growth.
The course of future inflation will be influenced by several factors, but the
greatest impact will come from oil production. Oil revenue will generate strong
demand for goods and services that is unlikely to be matched by supply because
of production and supply constraints and lags, which will fuel inflation. On the
other hand, oil revenue is likely to strengthen the exchange rate, which will
dampen the impact of import prices on domestic prices. The Single Spine Salary
Structure will exert both demand and cost pressures on inflation by
respectively boosting employees' incomes and increasing employers' costs.
Utility tariffs are likely to go up periodically, given persisting gaps between
 21
providers' costs and tariffs, and this will exert pressure on inflation. Food prices
will continue to be an important factor in the course of future inflation, given
prevailing bottlenecks in production, storage, and marketing that are unlikely to
be overcome anytime soon.7

7
Recent food supply trends have been very encouraging and have been a key driver of declining inflation. Should
this trend be sustained, and should food prices decline substantially, the impact on inflation could be phenomenal.
 22 The Institute of Economic Affairs

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