Asymmetric Interplay of Interest Rate and Inflation Rate on Exchange Rate in Ghana

Abstract

The relationship between interest rates, inflation, and exchange rates is crucial for macroeconomic stability, yet it often exhibits nonlinear and asymmetric behavior. This study investigates the dynamic interplay among these variables in the Ghanaian economy, employing advanced econometric methodologies, including Threshold Vector Autoregression (TVAR), Vector Error Correction Model (VECM), Impulse Response Function (IRF), and Granger Causality tests. Utilizing monthly data from 2015 to 2024, the research first establishes the presence of cointegration, confirming a long-term equilibrium relationship. The VECM framework is used to analyze short-term adjustments, while the TVAR model captures regime-dependent interactions under varying economic conditions. The results indicate that interest rate changes exert asymmetric effects on exchange rate movements, with inflation playing a more significant role in high-volatility periods. Granger causality tests reveal bidirectional causation between interest rates and inflation, suggesting monetary policy adjustments influence inflation dynamics and vice versa. Additionally, impulse response analysis highlights that exchange rate shocks tend to stabilize over time, whereas inflation-induced shocks cause prolonged currency depreciation. The findings underscore the need for a flexible monetary policy framework that considers regime-dependent dynamics to effectively manage inflation and exchange rate volatility. The studys insights provide policymakers with empirical evidence to design targeted interventions that enhance economic resilience and stability