Exchange rate volatility on the health and growth of the economy


The State shall take all necessary actions to ensure that the national economy is managed in such a manner as to maximise the rate of economic development and to secure the maximum welfare, freedom, and happiness of every person in Ghana, and to provide adequate means of livelihood and suitable employment and public assistance to the needy. The State shall, in particular, take all necessary steps to establish a sound and healthy economy whose underlying principles shall include”… Article 36(1)-(2) of the 1992 Constitution of Ghana

To ensure that economic progress is made while addressing fiscal and other macroeconomic concerns, monetary and fiscal policies have been adopted globally. For these policies and tactics to be effective, they had to be flexible and consistent with world trends – utilising a variety of tools, monetary policy attempts to control the supply, demand, and cost of money by the anticipated level of economic activity. Price stability, maintaining an equilibrium in the balance of payments, generating employment, output growth, and sustainable development may all be shared goals of monetary policy.

Ghana implemented a phased exchange rate liberalisation programme at the start of the 1980s, whereby market forces were given an ever-greater voice in establishing the foreign exchange value of the country’s currency – the cedi. This resulted in the first inter-bank foreign exchange market being established in the nation in 1992, while the parallel market – an unofficial currency market – was codified into the foreign exchange bureaux market. Since then, the transactions (supply and demand) that occur in the two markets have largely influenced the exchange rate of the cedi.

The value of the cedi has been highly unstable to other currencies since the liberalisation, with a large portion of the instability being characterised by devaluation. Policy-makers have been deeply concerned about this issue. A declining currency has some advantages, such as making export incentives stronger and deterring imports; but it also tends to come with significant immediate costs for the economy. These include rises in the domestic-currency value of foreign debt and debt servicing expenses, as well as the rapid pass-through effect on local inflation, which erodes real incomes, economic growth, and confidence. Governments have worked to foster the conditions for a stable exchange rate throughout time to reduce these expenditures. However, long-term exchange rate stability remains mainly elusive. The obvious inquiry is: “Why has this been the case?”

With the primary objective of maintaining price stability, the central bank has adopted a variety of techniques and policies and increased market supply to stop the depreciation of the cedi. The central bank’s steps haven’t stopped the cedi from depreciating, though. According to theory, macroeconomic variables influence exchange rate pricing. Therefore, it is still crucial to investigate the connections between macroeconomic factors and Ghana’s exchange rate pricing.

By investigating the correlation between these variables and prices of the exchange rate in Ghana based on the patterns found, the paper will intensify the central bank’s effort to help reduce the depreciation of the cedi. The central bank can then design suitable and enhanced tactics to deal with some of these issues.

The value of a country’s currency relative to another currency is known as the exchange rate. In international trade, a nation’s exchange rate may serve as a gauge of its level of competitiveness on the global stage. Therefore, exchange rate volatility has substantial, far-reaching effects on decision-makers, investors, businesses, and consumers. For instance, because it makes the return on investment unpredictable, exchange rate volatility has a detrimental impact on the decision to invest. Most Ghanaians, especially business people, are quite concerned about the fluctuating exchange rate between the Ghana cedi and other currencies, particularly the dollar.

The value of the exchange rate could appreciate, depreciate, or remain stable. The optimal currency exchange rate supports and sustains economic growth and industrial operations. The trade market’s overvaluation concerns with the current account and the artificially low prices of imports in comparison to the relatively high prices of exports may be affected by the currency’s improvement of the economy’s strength. This will improve a country’s ability to compete internationally. Worse trading conditions might result from a currency’s depreciation, which can make imports artificially expensive while keeping exports relatively cheaper. Based on this context, Ghana’s economic authorities need to create and implement a variety of policies targetted at establishing and maintaining currency stability.

When the exchange rate depreciates, it indicates that a greater proportion of domestic currency is needed to buy hard currency, whereas when the rate appreciates, a smaller proportion of domestic currency is required to buy hard currency. Exchange rate volatility is the term used to describe changes in exchange rates and departures from a benchmark trade market rate over time. Ghana had experienced some exchange rate turbulence.

Since it is of such importance and piques economists’ attention, the subject of how to establish and maintain exchange rate stability in Ghana still needs to be thoroughly researched. Most economists thought that Ghana’s currency was overvalued at the time the fixed exchange rate regime was implemented. However, despite the central bank’s market support and policy interventions, the introduction of a flexible exchange rate regime caused the country to record a depreciation in currency rates. What, therefore, is the key factor influencing the exchange rate in Ghana?

Authorities in domestic policy, like the Bank of Ghana, can gain a variety of policy lessons from the fact that real exchange rate variation is mostly explained by its volatility, and that the impact of exchange rate volatility on growth is non-linear. Which form of intervention in the exchange rate market is ideal? The author’s view is that shocks to the exchange rate can be self-correcting as long as a floating exchange rate system is in place.

The likelihood of excessive real exchange rate volatility is higher with ongoing exchange rate interventions, especially those that are not sterilised. To accurately estimate and anticipate both the level and volatility, a thorough grasp of the inputs that should go into the exchange rate policy equation is required. Thus, by more thorough examination, the central bank might enhance its research division in this area. Own volatility implies that the foreign exchange market does not appropriately represent the majority of the news. The public and markets would be better able to understand central bank operations if forecasts and policy decisions were transparent, which would reduce uncertainty and speculative activity.

For the stability of domestic prices, there are significant lessons. Particularly when shocks are real, like in terms of trade and output, active involvement in the exchange rate market may result in counterproductive policy responses. To tighten monetary policy in response to a currency depreciation brought on by FDI and portfolio shock, interest rates would need to be adjusted in a way to maintain an equilibrium. Inflation is also maintained to a minimum in this way. A policy response that favours appreciation of the currency rate as a result of portfolio shock would be necessary. An expansionary monetary policy would be necessary to counteract currency depreciation caused by a shock to the terms of trade that reduces aggregate demand and the demand for exports.

The likelihood of inflation caused by these policy responses is lower. However, currency depreciation or appreciation brought on by an output or productivity shock wouldn’t call for monetary policy intervention, and would be seen to be in line with the market’s assessment of equilibrium. This is because a highly misaligned exchange rate would display excessive volatility (both current and prospective) in attempting to establish its equilibrium rate, which is primarily influenced by its factors.

In an inflation-target regime, the central bank should not only be concerned with lowering inflation volatility, it should also give critical consideration to lowering exchange rate variations, particularly when the latter are self-driven. The monetary authorities should strengthen the transparency of monetary policy, notably on managing exchange rates, as this has potential channels of impact on internal and external stability to reduce the chance that exchange rate takes precedence over inflation targetting as the nominal anchor. To conduct an effrontery policy, policy-makers must take into account asset prices and exchange rates in particular when deciding on the instrument for monetary policy because this is in line with inflation targetting.

In a sample of 95 developing nations, Dollar et al conducted research on the influence of exchange rate volatility on growth, and they discovered a negative association between the two. It also demonstrates how declining total factor productivity lowers growth by increasing real exchange rate volatility. The real output growth and price inflation are impacted by exchange rate movements in a sample of 22 emerging nations. According to the authors, depending on the level of openness, currency rate volatility and depreciation in particular, harm economic performance by slowing inflation and production growth. The long-term effects of expected exchange rate volatility considerably affect inflation and economic growth in opposite directions.

Exchange rate volatility allows countries to examine their potential for growth and development while maintaining an adequate and stable exchange rate. It has been determined that excessive exchange rate volatility lowers the pace of economic growth by fostering business uncertainty, eroding competitiveness, lowering productivity and profits, and raising domestic prices. This affects welfare and ought to be a priority for policy. Aligning the exchange rate with the fundamentals is necessary to steer changes in the real exchange rate. As a result, both domestic stability and external competitiveness are preserved.

In conclusion, over the long term, changes in domestic GDP, the money supply, terms of trade shocks, FDI flows, and government expenditure increases all have a considerable impact on exchange rate volatility and the health of the economy. Analysis of the shocks reveals that roughly three-quarters of the volatility in exchange rates is self-driven. This suggests that because exchange rate volatility is essentially self-driven, unrestrained interventions may not only make the volatility worse, but also be expensive in terms of output and welfare. The foreign currency market could function more transparently if central banks improved their forecasting and modelling of exchange rates and took into account the effects of asset prices on domestic monetary policy.


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The writer is a Ph.D. candidate, CEPA, CFIP, ATA MIPA, ChMC, AMCFE, and Researcher

Contact: 0246390969 – Email: [email protected]


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