Abstract

This paper empirically assesses the structural rationale for the official monetary policy regime shift in Ghana (2002) from monetary targeting to explicit inflation targeting, which was against the backdrop of financial sector reforms as part of the Structural Adjustments Reforms (SARs) programme which began in 1985.

The paper analyses structural change in the monetary transmission mechanism by estimating benchmark FAVAR model of the MTM for the period 1960-1985, against an augmented FAVAR model which incorporates a constructed Financial Structure Index (using Principal Factor Analysis) for the period 1986 to 2015. This captures the MTM for the periods before the financial sector reforms in 1985 and after the reforms (post 1985). The augmented FAVAR estimates the significance of structural change in the financial system and the overall implications for the effectiveness of interest rates-based inflation targeting monetary policy regime as a rationale for the regime shift.

The findings provide evidence of structural change in the post reform monetary transmission mechanism and providing the empirical and structural rational for the regime shift to inflation targeting in 2002 view. The augmented FAVAR provides evidence of significant long run causality from the Monetary Policy Rate (interest rates-based tool) to the financial structure index, broad money supply to inflation and GDP growth. The pre-reform model shows weak long run causality from the Monetary Policy Rate to inflation and GDP growth. The findings conclude there was a structural rationale for the post reform monetary policy regime shift from monetary targeting to inflation targeting in 2002 by the Bank of Ghana.

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