Does interest rate shocks transmit from united states to Ghana?: Evidence from vector auto-regression

In the heat of severe global macroeconomic volatility, monetary authorities in the developing world are faced with the challenge of identifying the sources of such volatilities in their countries. Previous studies on developed countries have attributed home country macroeconomic shocks to monetary policy shocks in foreign countries. Consequently, it was suspected that interest rate shocks in trading partner countries such as the United States might be contributing to macroeconomic shocks in Ghana. Hence, the need to replicate such studies on Ghana becomes imperative. Therefore, this paper aims at (i) ascertaining whether Ghana’s interest rate respond to the interest rate shocks in USA (ii) finding out if interest rate shocks in USA affect other basic macroeconomic variables of the Ghanaian economy. Data on four Ghanaian variables of real gross domestic product, consumer price index, exchange rate and interest rate were collected. Data on U.S variables (federal fund rate and the world consumer price index) were also collected. All data series were annual and span the period, 1983 to 2011. A VAR model of the Ghanaian economy was specified assuming the U.S variables to be exogenous, affecting the vector of endogenous Ghanaian variables contemporaneously. To automatically resolve the problem of unit root found in our series when the mean reversion status of the series were checked, a VECM of the VAR model was estimated. The study further generated the impulse responses (IR) of the Ghanaian variables to variables of the United States. The impulse response analysis of our VAR model shows that in general, interest rate shocks in the United States as well as shocks in the global consumer prices led to insignificant fluctuations in the Ghanaian macro economy. While the countries’ real gross domestic product, interest rates and consumer price indices responded insignificantly to shocks originating from the United States (the upper standard error band fluctuated between 0.00 and 0.50 and the lower standard error band fluctuated between -0.00 and -0.40), its exchange rate responded significantly to shocks from U.S exchange rates (the upper standard error band took off from 0.00, went down to -0.03 before going up to 0.02 while its lower standard error band fluctuated between -0.00 and -0.4). By implication, macroeconomic shocks in Ghana are mostly home-made. To avoid being misled into wrong policy decisions, policy makers in Ghana were therefore advised to always strike a balance between imported and home-made shocks when allocating their policy making resources.