INFLATION TARGETING AND MONETARY POLICY INSTRUMENTS: EVIDENCE FROM NIGERIAN AND GHANA

Abstract

This paper attempts to examine whether or not one of the preconditions for a successful inflation – targeting framework is present in Nigeria and Ghana. That is, the paper wants to find out whether or not a stable and predictable relationship exists between inflation and monetary policy instruments in these countries. In achieving this objective, vector autoregressive models are built in line with the work of Goltschalk and Moore (2002) and Tutar (2002). Specifically, three VAR models are estimated starting with a two-variable model including money supply and prices, and then, adding some financial variables such as nominal exchange rate and interest rates in order to see their contribution to a VAR system for Nigeria and Ghana. It is observed from the VAR twovariable model that inflation is an inertial phenomenon in Nigeria and Ghana, and money innovations are not strong and statistically important is determining prices when compared will price shocks themselves. When adding financial variables like exchange rates and interest rates to the models, the paper does not observe any significant improvement in the model. In the short run, innovations in prices are mostly explained by their own shocks, the monetary policy instruments, such as interest rates and exchange rates, have little or no effect on prices. Therefore
policy linkage between inflation and monetary policy instruments in Nigeria and Ghana is not strong in the short run and thus, these countries are not yet candidates for inflation targeting.