Munich Personal RePEc Archive

Real Exchange Rate Volatility and Domestic Consumption in Ghana

Njindan Iyke, Bernard and Ho, Sin-Yu (2017): Real Exchange Rate Volatility and Domestic Consumption in Ghana. Forthcoming in: Journal of Risk Finance

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Abstract

Consumption forms a vital component of aggregate demand. Hence, its behaviour influences business cycles, long-term growth, employment and macroeconomic policy decisions. The literature has therefore focused on establishing the determinants of consumption. Chiefly among the key determinants established in the literature are income and the interest rate. The recent literature has added changes in the real exchange rate and its volatility as critical factors influencing consumption decisions, owing to their pass-through effects on inflation and inflation volatility. The extant studies have examined the effects of exchange rate volatility on consumption by considering countries in regions other than Sub-Saharan Africa (SSA). In this paper, we examined this issue by focusing on a small open SSA country, Ghana, which has experienced exchange rate volatility. Using annual data covering the period 1980–2015, and the annualised variance of the real exchange rate as a measure of exchange rate volatility, we found that exchange rate volatility has negative effects on domestic consumption in the short run, which is passed on as negative long-run effects. This conclusion is unaffected by an alternative measure of exchange rate volatility and the choice of lag restrictions. Our finding suggests that policymakers should seek to reduce or prevent exchange rate volatility by pursuing various policies including limiting foreign currency transactions within the country, and promoting quality exports.

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