Rethinking Price Stability in Ghana: Fiscal Dominance, Debt Sustainability, and the Relevance of Fiscal Theory of Price Levels (FTPL)

Abstract

This study rethinks the factors that influence price stability in Ghana within the framework of fiscal dominance, debt sustainability, and conflicting theories of inflation determination, such as the Fiscal Theory of the Price Level (FTPL) and monetarist viewpoints. Ghana still faces frequent inflationary pressures after decades of stabilization efforts, which raises significant concerns regarding how fiscal-monetary interactions influence inflation dynamics. The study's primary goal is to examine the main causes of inflation, paying special attention to the asymmetrical effects of fiscal shocks, the money supply's cyclical role, the interest rate policy's paradoxical effects, and the impact of real economic activity through the output gap. The study uses the Nonlinear Autoregressive Distributed Lag (NARDL) model and uses annual time-series data for Ghana from 1980 to 2023. This methodological technique is especially well-suited to capturing both short-run and long-run dynamics, as well as investigating nonlinearities and asymmetries in the inflation process. While diagnostic and stability checks, such as the CUSUM and CUSUMSQ tests, established the robustness of the model specifications and parameter stability, standard unit root and cointegration tests verified the existence of stable long-run relationships among the variables. The findings indicate that shocks do not last forever since Ghana's inflation is mean-reverting and historical inflation has a gradual dampening effect. However, the impacts of fiscal policy are asymmetrical: whereas consolidations raise inflation, deficit expansions lower it. This is a reflection of Ghana's fiscal dominance issue, where deficit-financed expenditure momentarily suppresses prices at the expense of fiscal sustainability, while fiscal consolidation measures like tax hikes or the elimination of subsidies create inflationary pressures. Although complex, monetary policy variables also have an impact. Growth in the money supply is a major driver of inflation, albeit with varying effects over time lags, suggesting cycles of expansion and correction as the Bank of Ghana switches between tightening and liquidity injections. Furthermore, the interest rate paradox becomes apparent: higher interest rates are linked to higher inflation rather than lower inflation. Since higher rates increase the cost of servicing debt, which in turn drives inflation, this counterintuitive result highlights weak monetary transmission under fiscal supremacy. Lastly, the output gap confirms demand-pull pressures that are in line with the Phillips curve and has a positive and significant effect. Overall, fiscal dominance, poor monetary transmission, and ongoing demand-side forces have formed Ghana's inflation dynamics, which show a hybrid process. Credible inflation targeting, phased fiscal adjustments, improved fiscal discipline, and closer fiscal–monetary coordination are all necessary to guarantee long-term price stability.