Monetary Policy Rule In Ghana: Is There A Case For An Augmented Nonlinear Taylor Rule

Abstract

Monetary policy is an essential tool for economic development; hence, management of monetary policy is crucial and must be well understood. An interest rate rule like the Taylor rule was developed to analyze monetary policy conduct and give a clear direction of interest rate setting behaviour. Most studies analyzing monetary policy conduct in Ghana assume linearity and symmetry in conduct from the Central Bank though that may not represent actual policy conduct. This study looked at monetary policy conduct in Ghana from May 2007 to December 2019 (the official inflation targeting period) and investigated possible nonlinearities in monetary policy conduct. Hence monthly data from May 2007 to December 2019 was used. The study used the ARDL and NARDL to investigate asymmetries in monetary policy conduct. The study first observed the importance of the real effective exchange rate in monetary policy conduct as it significantly affected the policy rate decisions. The study found an asymmetric response in deviations in the exchange rates in the short run. In the long run, there was also an asymmetric response to inflation gap deviations as the policy rate reacted strongly to negative deviations but had an insignificant response to positive deviations. The study proposes that for the Central Bank to be effective in the conduct of monetary policy, it must respond to deviations more symmetrically or depict inflation-stabilizing behaviour. This will improve the credibility of policy conduct so that economic agents always know that price stability is always the central bank's primary goal.