Is the interest rate setting behaviour of the Bank of Ghana constrained by high debt levels?

Abstract

While assertions of debt constraints on monetary policy have been documented in the literature, empirical investigation into this phenomenon remains egregiously limited, with the only study using the Generalized Method of Moments that fails to provide confidence intervals for the threshold estimate. We examine whether or not high debt levels constrain the interest rate setting behaviour of the Bank of Ghana, with the aid of sample splitting and a threshold estimation technique that overcomes the weaknesses of previous studies. We find that monetary policy response to inflation gap in the high debt regime (above the debt to gross domestic product [GDP] threshold of 35.1%) is woefully disproportionate, a key indication of debt constraint and inflation accommodation by a central bank that is supposed to be targeting inflation. Important policy recommendations are proffered.

The Relationship Between Policy Rates and Domestic Debt in Ghana

“…To alleviate the burden of government debt servicing and accumulation, interest rates can be kept at lower levels. This is because high levels of debt, coupled with an increase in interest rates, can further burden the government and lead to more borrowing (Iddrisu & Alagidede, 2020). However, it is important to consider that lowering interest rates can also have counterproductive effects, such as increasing inflation.…”

“…This creates a dilemma for central banks, as they must balance stabilizing rising inflation by adjusting interest rates or implementing policies to reduce the burden of public debt on fiscal authorities. According to Iddrisu & Alagidede (2020), "for inflation targeting central banks, this has serious consequences for the publicly announced inflation target, commitment to achieving it, and detrimental effects on public confidence and the need to anchor inflation expectations." Therefore, in the face of increasing public debt, adopting a tighter monetary policy stance only amplifies the burden on the existing debt stock, which can ultimately widen the budget deficit gap.…”

“…Given the importance of understanding the relationship between policy rates and domestic debt, it is crucial for researchers and policymakers to investigate this issue further. With the exception of Karanja (2013), empirical investigations on this topic have been limited, with most studies focusing on public debt (or external debt) and interest rate (Iddrisu &Alagidede, 2020 andMitra, 2007). But since monetary policy operation is not universal but country-specific, it provides this study enough grounds to look at it from the Ghanaian perspective.…”

Les Déterminants des Prêts Non Performants du Système Bancaire de l'UMOA

“…La relation entre le taux d'intérêt réel et les créances douteuses est documentée par Iddrisu et Alagidede (2020) et Bofondi et Ropele (2011) en Italie. Ces auteurs montrent que la hausse du coût de l'emprunt, la nature des emprunteurs mesurée par le ratio des créances douteuses précédentes, la faible diversification des économies et les chocs agissent sur le fardeau de la dette, augmentant les PNP.…”

Prospects and Impediments of Railway Infrastructure Development in Ghana: Impact of Standard Gauge Railway (SGR) Technology

“…A report by the World Bank (2020), shows that the mega project is expected to not only increase local job creation but also strengthen local SMEs in the construction sectors, especially for those who have been heavily hit by the impact of the Covid19 outbreak (Ministry of Railways Development 2019; World Bank 2020). Although, there are a lot of potentials from railway project, studies(Iddrisu and Alagidede 2020;Liedong and Rajwani 2018) argued that, citizens especially the educated ones are full of mixed feelings and are more concern about the rise in national debt despite a progress in infrastructure development. Despite abundant natural resources, Ghana continues to borrow from international bodies, including the World Bank and China's Sino Financial facilities.…”