Thesis Project - Rasmussen-Tetteh - 072407

8/12/2019 Thesis Project - Rasmussen-Tetteh - 072407

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Thesis Project

The Impact of Inflation onBusiness and Trade: a case study

of Ghana and Canada

Prepared by:

Kris RasmussenDaniel Odei Tetteh

Supervised by:Dr. Ian Robson


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The Impact of Inflation on Business and Trade: a case study of Ghana and Canada

Submitted on:July 24 2!!"

Acknowledgments:

Our #irst and #oremost than$s %o to the &lmi%hty 'od #or his prote(tion and%rantin% us )isdom #or the (ompletion o# this thesis.

This thesis )ould not have been (ompleted )ithout the help o# these people:

*irst o# all )e )ould li$e to than$ our thesis supervisor Dr Ian Robson #or his%uidan(e and dire(tion throu%hout this )or$. +e are also %rate#ul to Dr KlausSolber% #or his (ounselin% and dire(tion in #ormulatin% the thesis proposal.

Daniel Odei Tetteh )ants to than$ ,mmanuel O)usu-riyie o# an$ o# 'hana

#or his immense support and (ounselin% also ,mmanuel Dod/i #rom 'hanaStatisti(al Servi(e #or helpin% me in the data (olle(tion and or%ani/ation. 0e also)ants to than$ my dear )i#e )ho supports and en(oura%es him

Kris Rasmussen )ould li$e to than$ his #amily #or their support and advi(e )hile)or$in% on this thesis.

*inally )e also )ant to than$ students in the 1& Part-time #or their (ritiue(omments and su%%estions.

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Abstract:

The thesis loo$s at the relationship bet)een in#lation interest rate e3(han%e rateand 'DP #or a developed (ountry 5anada6 and a developin% (ountry 'hana6.Throu%h a detailed literature sear(h loo$in% at the e(onomies o# 'hana and

5anada as )ell as statisti(al analysis usin% least suares and re%ression modelsthe #ollo)in% uestions )ere addressed:

76 +hat is the impa(t o# in#lation on businesses and trade8

26 1ost businesses depend on loans to run their business operations. +hatis the (orrelation bet)een in#lation and interest rate both in 'hana and5anada8

96 0o) is in#lation a##e(tin% the e3(han%e rate development o# import ande3port8 +hat is the e##e(t on businesses that depend mostly on imported

ra) material #or produ(tion8

46 0o) is monetary poli(y used in 5anada to (ontrol in#lation and ho) doesthis (ompare to the poli(y bein% used in 'hana8

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Table of Contents

Thesis Project.......................................................................................................................1

Acknowledgments:..............................................................................................................2Abstract:...............................................................................................................................3

Table of Contents.................................................................................................................4

1Introdction........................................................................................................................!1.1"ackgrond.................................................................................................................!

1.2Problem.......................................................................................................................#

1.3$bjecti%e.....................................................................................................................#

1.4&ele%ance....................................................................................................................'1.!$tline.........................................................................................................................'

2(iteratre &e%iew...............................................................................................................'

2.1Inflation )efined.........................................................................................................'2.2*easres of Inflation..................................................................................................+

2.3T,-es of Inflation........................................................................................................

2.4Theories of Inflation...................................................................................................

2.!&easons to Control Inflation.....................................................................................132.#*ethods /sed to Control Inflation...........................................................................13

2.'Inflation and Interest &ates.......................................................................................1!

2.+0change &ate Trade and Inflation........................................................................1'3The 0conomies of hana and Canada.............................................................................23

3.1hana5s 0conom,.....................................................................................................23

3.2Canada5s 0conom,...................................................................................................233.3ross )omestic Prodct )P................................................................................23

3.4Interest &ate..............................................................................................................2!

3.!Inflation.....................................................................................................................2+4Inflation Control in hana...............................................................................................2

4.1&eglation.................................................................................................................24.2Crrenc,....................................................................................................................364.37IPC Initiati%e..........................................................................................................31

4.48ood and "e%erages..................................................................................................32

4.!9on 8ood Inde......................................................................................................32

4.#*one, ;--l,...........................................................................................................324.'o%ernment 0-enditre..........................................................................................34

!*ethodolog, and 0stimation...........................................................................................3'

!.1*ethodolog,.............................................................................................................3'!.20stimation.................................................................................................................3'

!.3(imitations of the *odels.........................................................................................43

#Conclsions......................................................................................................................44';orces.............................................................................................................................4#

+A--endi..........................................................................................................................4'

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Introduction

1.1 Background

Developin% (ountries o#ten #a(e many e(onomi( issues as their e(onomi( andpoliti(al systems %ro) and 'hana is no e3(eption to this. Sin(e 'hana de(lared

independen(e #rom ritain in 7;" there have been many (oups anddi(tatorships )hi(h resulted in a destabili/ed %overnment and e(onomy. In 72the (ountry voted 2< in #avor o# a re#erendum )hi(h removed the ban onopposition politi(al parties and paved the )ay to #ree ele(tions in 79.

Over this time 'hana=s e(onomy )as badly dama%ed. e#ore independen(e it isestimated that 'hana had rou%hly >S?4@7-million in reserves but by the mid-7A!=s these reserves )ere %one and 'hana )as havin% trouble meetin%repayment plans to its (reditors. 1u(h o# these #unds )ere used on lar%e publi(proBe(ts and poorly thou%ht out a%ri(ultural and industrial s(hemes and by themid-7"!=s 'hana )as >S


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'ross Domesti( Produ(t 'DP6 )hi(h measures the total output o# a (ountry=se(onomy is a##e(ted ne%atively i# pur(hasin% po)er is lo). Demand #or %oodsand servi(es de(reases as in#lation in(reases and this in turn redu(espur(hasin% po)er and lo)ers demand #or %oods and servi(es de(reasin% the

national output. usinesses )hi(h produ(e those %oods and servi(es area##e(ted ne%atively and their outputs )hi(h #orm the national output de(reases.

Import and ,3port o# %oods and servi(es dominates )orld trade in the 27 st(entury. Transa(tion o# trade is done in (urren(y. ,3(han%e rates play a $eyrole in )orld trade and this thesis try to study the in#luen(e o# in#lation one3(han%e rate. There are t)o type o# e3(han%e rate re%imeE these are the #i3ede3(han%e and the #loatin% e3(han%e. There is a stron% lin$ bet)een #i3ede3(han%e rate and lo) in#lation. This is be(ause the #i3ed e3(han%e rateprovides hi%hly visible dis(ipline and (ommitment. Over time (ountries tend toabandon the #i3ed e3(han%e rate re%ime and adopted the #loatin% e3(han%e rate

re%ime. In#lation and #loatin% e3(han%e rate have a stron% relationship.

1.2 Problem

The purpose o# this thesis is to e3amine the impa(t o# in#lation on businesses andtrade. +e )ill study the impa(t o# in#lation on businesses and international tradeby doin% an analysis on 'hana a developin% e(onomy6 and 5anada adeveloped e(onomy6.

1.3 Objective

This study is interested in ho) in#lation poli(y is used to (ontrol interest rate thein#luen(e o# #loatin% e3(han%e rate on in#lation and ho) in#lation a##e(ts nationalin(ome 'DP6. This paper )ill also investi%ate the in#luen(e o# interest rateE#loatin% e3(han%e rate and national in(ome 'DP6 on in#lation.

Over the (ourse o# this thesis )e hope to ans)er the #ollo)in%:

+hat is the impa(t o# in#lation on businesses and trade8

1ost businesses depend on loans to run their business operations.+hat is the (orrelation bet)een in#lation and interest rate both in'hana and 5anada8

0o) is in#lation a##e(tin% the e3(han%e rate development o# import ande3port8 +hat is the e##e(t on businesses that depend mostly onimported ra) material #or produ(tion8

0o) is monetary poli(y used in 5anada to (ontrol in#lation and ho)does this (ompare to the poli(y bein% used in 'hana8

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1.4 Relevance

5ompanies depend on borro)in% to e3pand their business the %oal o# this studyis to establish the relationship bet)een in#lation and interest rate this )ill allo)businesses to better plan. &lso as some businesses depend on imported ra)materials #or their produ(tion and some businesses e3port many o# their

produ(ts the (orrelation o# in#lation and #loatin% e3(han%e rate )ill help them toma$e %ood de(isions.

1.5 Outline

The study )ill be stru(tured as #ollo)s.

The #irst se(tion (on(entrates on the introdu(tionE dealin% )ith the ba($%round o#the study the obBe(tive o# the study and the relevan(e o# the study.

Se(tion t)o introdu(es in#lation theory the theoreti(al impa(ts o# in#lation and

brie#ly revie) methods used to (ontrol in#lation.

Se(tion three provides details on the e(onomies o# 'hana and 5anada.

Se(tion #our )ill dis(uss in#lation (ontrol in 'hana.

Se(tion #ive addresses the methodolo%y and estimation o# models.

The last se(tions )ill (on(entrate on #indin%s o# the study analysis and the(on(lusions dra)n.

! "iterature #e$iew

2.1 Inflation Defined

The simplest de#inition o# in#lation is that in#lation is Ftoo mu(h money (hasin% too#e) %oodsF7 a more thorou%h de#inition ho)ever )ould be that in#lation is G&persistent in(rease in the level o# (onsumer pri(es or a persistent de(line in the

1'eor%e +. +ilson In#lation 5auses 5onseuen(es and 5ures 7st ed. loomin%ton IC:Indiana >niversity Press 7@26 7Kris Rasmussen

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pur(hasin% po)er o# money (aused by an in(rease in available (urren(y and(redit beyond the proportion o# available %oods and servi(esH 2.

+hatever the de#inition ho)ever the results are the same in#lation means thatover time a (onsumer or (ompany (an pur(hase less )ith their money. Over

time the (ost o# a %ood or servi(e )ill rise meanin% that the pur(hase po)er o#the (onsumer or (ompany )ill be de(reased. *or e3ample i# the annual in#lationrate is ;.!< a (ho(olate bar bou%ht today #or ?7.!! )ould (ost ?7.!; a year #romno).

2.2 ea!ure! of Inflation

In#lation (an be measured in a number o# )ays. The #irst )ay is by usin% the5onsumer Pri(e Inde3 5PI6. The 5PI loo$s at the pri(e (han%es o# a Gbas$etH o#(ommon (onsumer %oods and servi(es i.e. #ood (lothin% %asoline6. In the>nited States this data is (omplied by the ureau o# abor Statisti(s S6 and

released monthly. &s an e3ample the >S (ity data #or *ebruary =!" sho)s thatthe 5PI has in(rease by !.;< over January and by 2.4< over *ebruary =!A 9.This measurement %ives a %ood vie) o# ho) the (osts o# %ood and servi(es are(han%in% over time #rom the perspe(tive o# the (onsumer.

&nother measure that is used is the Produ(er Pri(e Inde3es PPI6. The PPI are aset o# inde3es that measure the (han%e in sellin% pri(e that a produ(er is able to%et #or a %ood or servi(e. In the >nited States this data is a%ain (olle(ted and(ompiles by the S and published monthly. The inde3es are separated by(ommodity and industry se(tor. Some o# the (ommodities (onsidered are:#inished %oods intermediate %oods (rude %oods passen%er (ars %asoline and

pharma(euti(als. i$e)ise on the industry side some industries (onsidered are:%eneral )arehousin% and stora%e ele(tri( po)er distribution %eneral medi(aland sur%i(al hospitals and o##i(es o# la)yers.

In the lon% run the PPI and 5PI )ill sho) similar rates o# in#lation. These indi(esho)ever (an %ive an in#lated vie) o# the rate o# in#lation4. The 5PI #or instan(eassumes that the same uantity o# produ(t is bou%ht by the (onsumer year overyear this i%nores the #a(t that as pri(es in(rease (onsumer pre#eren(e may(han%e #or e3ample i# the pri(e o# bee# in(rease dramati(ally the (onsumer maybe%in to buy poultry instead meanin% that their #ood (osts mi%ht not be as hi%h.*or this reason a third method is used to determine the rate o# in#lation. This

third measure is the 'ross Cational Produ(t 'CP6 de#lator. The 'CP de#lator is2The &meri(an 0erita%e Di(tionary o# the ,n%lish an%ua%e. 4thed. 0ou%hton 1i##lin 5ompany2!!!6.

3U.S. Department of Labor Bureau of Labor Statistics website4'eor%e +. +ilson In#lation 5auses 5onseuen(es and 5ures 7st ed. loomin%ton IC:Indiana >niversity Press 7@26 9@

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a measure o# the (han%es in pri(es o# all #inal %oods and servi(es produ(ed. Theadvanta%e that the 'CP de#lator measurement has over 5PI is that it (onsidersall o# the #inal %oods and servi(es in the e(onomy )hile the 5PI only (onsidersthe %oods and servi(es in(luded in the Gbas$etH. &lso the 'CP de#lator uses the(urrent year proportions meanin% that it ta$es into a((ount (han%es in demand

)hile the 5PI uses #i3ed proportions year over year.

2.3 "#$e! of Inflation

The main types in#lation that are typi(ally (onsidered are demand-pull in#lationand (ost-push in#lation;.

!%&% 'emand(Pull Inflation

Demand-Pull in#lation des(ribes in#lation that o((urs #or the most basi( o#e(onomi( reasons that is that pri(es #or a %ood in(rease be(ause demand #or aprodu(t e3(eeds supply. *or demand-pull in#lation to o((ur #ull-employment must

be in pla(e so that any in(rease in demand (annot be met simply by employin%more resour(es to produ(e more o# a produ(t.

!%&%! Cost(Push Inflation

5ost-Push in#lation o((urs i# there is a drop in output o# a produ(t usually due toan in(rease in (osts either throu%h in(reased produ(tion (osts or ta3es orthrou%h some other $ind o# adverse sho($ su(h as a supply shorta%e or a ra)material. In this (ase the e(onomy )ill e3perien(e both hi%her pri(es andshorta%es o# the produ(t.

2.4 "%eorie! of Inflation,(onomists hold t)o sli%htly di##erent theories o# in#lation the uantity Theoryand Institutional Theory. The uantity theory emphasi/es the (onne(tion bet)eenmoney and in#lation: the institutional theory emphasi/e mar$et stru(ture andpri(e-settin% institutions and in#lation. There is a si%ni#i(ant overlap bet)een thet)o theories but be(ause they (ome to di##erent poli(y (on(lusions it is help#ulto (onsider them separately.

!%)% The *uantity Theory of +oney and Inflation

The uantity theory o# money (an be summed up in one senten(e in#lation isal)ays and every)here a monetary phenomena. I# the money supply rises the

pri(e level )ill rise. I# the money supply doesn=t rise the pri(e level )on=t rise.

The ,uation o# ,3(han%eThe uantity theory o# money (enters on the euation o# e3(han%e an euationstatin% that the uantity o# money times velo(ity o# money euals the pri(e leveltimes the uantity o# real %oods sold. This euation is:

1L P

!Thomas +ilson In#lation 5ambrid%e 1&: 0arvard >niversity Press 7A76 7;Kris Rasmussen

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)here 1L uantity o# money L elo(ity o# money PL Pri(e level and Luantity o# real %oods sold. is the real output o# the e(onomy real 'DP6 and Pis the pri(e level so P is the e(onomy=s nominal output nominal 'DP6. thevelo(ity o# money is the number o# times per year on avera%e a dollar %oesaround %eneratin% a dollar )orth o# in(ome or elo(ity is the amount o# in(ome

per year %enerated by a dollar o# money. 1L P 1 also euals nominaloutput.,3ample: 5anada situation: in 7 nominal 'DP L ?7!!!billion and1L?@!billion usin% 176 so velo(ity )as about 'DPM1 L 79 meanin% ea(hdollar in the e(onomy (ir(ulated enou%h to support appro3imately ?79 in totalin(ome.

,elocity is Constant.There are t)o assumptions o# the euation o# e3(han%e:

76 The assumption is that velo(ity remains (onstant. 1oney is spent only

so #ast ho) #ast is determined by the e(onomy=s institutional stru(turesu(h as ho) (lose individuals live to stores ho) people are paid)ee$ly bi)ee$ly or monthly6 and )hat sour(es o# (redit are available.This institutional stru(ture (han%es slo)ly uantity theorists ar%ue sovelo(ity )on=t #lu(tuate very mu(h. I# velo(ity remains (onstant theuantity theory (an be used to predi(t ho) mu(h nominal 'DP )ill%ro) i# )e $no) ho) mu(h the money supply %ro)s. *or e3ample i#the money supply %oes up A


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,3pansionary monetary poli(y initially in(reasin% real output as pri(es )ere slo)to respond to in(reases in a%%re%ate demand. In the lon% run the e3pansionarymonetary poli(y (aused in#lation.

In 7"!s )hen si%ni#i(ant in#lation 7!< had be(ome built into the e3pe(tations o#

the e(onomy. In late 7" and the early 7@!s the *ed de(reased the moneysupply %ro)th si%ni#i(antly. This led to leap in unemployment #rom " to 7!


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Ce) Nealand le%ally mandated a monetary rule based on in#lation. In 7@ theReserve an$ o# Ce) Nealand )as reuired to $eep (onsumer pri(e in#lationbet)een !< and 2< a year a tar%et a%reed on by the (entral ban$. teravera%in% 7!< a year in the 7@!s Ce) Nealand=s in#lation rate #ell in the early

7!s and avera%e belo) 2< per year therea#ter. &n important reason Ce)Nealand instituted monetary rules )as to establish (reditability in its (entralban$=s resolve to lo)er the in#lation rate.

The >.S *ederal Reserve an$ does not have su(h a stri(t rule but the *ed)or$s hard to sho) that it is serious about #i%htin% in#lation re%ardless o# the(onseuen(es to unemployment or output. 1any e(onomists #elt that by the mid-7!s the *ed had established its (redibility and that (redibility allo)ed thee(onomy to e3pand )ithout %eneratin% in#lation. In#lation e3pe(tations #elllo)erin% interest rates )hi(h (ontributed to the investment boom o# the late7!s.

The (onstitution states that the ,uropean 5entral an$=s sole %oal is to #i%htin#lation. This )ill si%ni#i(antly redu(e politi(al (onsiderations in the (entral ban$=spoli(ies. In the year 2!!2 the euro the ,uropean >nion=s (urren(y6 is #ullyimplemented by parti(ipatin% member nations to see the e##e(tiveness o# thisapproa(h to establish (entral ban$ independen(e and lo) in#lation.

!%)%! The Institutional Theory of Inflation

Supporters o# the institutional theory o# in#lation a((ept mu(h o# the uantitytheory-money and in#lation does move to%ether. &((ordin% to the uantity theory

o# money (han%es in the money supply (auses (han%es in the pri(e level. Thedire(tion o# (ausation %oes #rom le#t to ri%htE1 P

Institutional theorists see it the other )ay around. In(reases in pri(es #or(e%overnment to in(rease the money supply or (ause unemployment. The dire(tiono# (ausation %oes #rom ri%ht to le#tE

1 P.

&((ordin% to the institutional theory o# in#lation the sour(e o# in#lation is in thepri(e-settin% pro(ess o# #irms. +hen settin% pri(es #irms and individuals #ind it

easier to raise pri(es rather than lo)er them and do not ta$e into a((ount thee##e(t o# their pri(in% de(isions on the pri(e level.

&ll in(ome is ultimately paid to individual o)ners o# the #a(tors o# produ(tionE therevenue that #irms re(eive is divided amon% pro#its )a%es and rent. *irms aresimply intermediaries bet)een individuals as o)ners o# the #a(tors o# produ(tionand individuals as (onsumers. 'ive the institutional stru(ture o# our e(onomy it=so#ten easier #or #irms to in(rease )a%es pro#its and rents to $eep the pea(e )ith

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their employees and other o)ner=s o# the #a(tors o# produ(tion than it is to try tohold those (osts do)n. *irms then pay #or that in(rease by raisin% the pri(es they(han%e (onsumers. In response to the risin% pri(e level the %overnmentin(reases the money supply so that there is su##i(ient demand to buy the %oodsat the hi%her pri(es.

,3ample: >nilever 'hana TD is happy )ith its (ompetitive position in themar$et its e3pe(t 7!< in#lation rate. Produ(tivity output o# soap per unit o#input6 is in(reasin% by 72< the same as the in(rease in produ(tivity in thee(onomy as a )hole so the #irm (an hold its nominal pri(e o# >nilever (onstanteven i# it in(reases )a%es by 7!nilever may (onsider pay 72< pay rise and raisin%the pri(e o# its produ(t. There#ore )hether the #irm (hooses this

2.5 Rea!on! to &ontrol Inflation

There are a number o# reasons that hi%her in#lation (an be disadvanta%eous toindividuals and a so(iety as a )hole. *or individuals on #i3ed in(omes su(h aspensioners as the (ost o# %oods and servi(es in(rease due to the e##e(ts o#in#lation their buyin% po)er de(reases. &lso personal savin% (an be dis(oura%edparti(ularly i# the rate o# return is lo)er than the rate o# in#lation this is some)hatalleviated by the advent o# inde3ed bonds in many industriali/ed (ountries A.

On a so(ietal level hi%h in#lation (an (reate some problems as )ell. I# in#lation ishi%h in one (ountry its e3ports )ill be(ome more e3pensive #or other (ountries topur(hase meanin% that a trade de#i(it (an be (reated. &lso in#lation (an lead to)a%e spiral )here )a%es are in(reased to $eep up )ith in#lation this in turn (an

lead to #urther in#lation.

2.' et%od! (!ed to &ontrol Inflation

Typi(ally a %overnment=s (entral ban$ is responsible #or (ontrollin% in#lation.Some (entral ban$s only respond )hen in#lation in(reases above a set tar%et

#"Costs of Inflation," World Economic Outlook, 1!

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)hile others #ollo) a symmetri(al in#lation tar%et meanin% that they a(t )henin#lation is deemed to be either too hi%h or too lo).

There are a number o# )ays #or a %overnment to (ontrol in#lation. One )ay isthrou%h monetary poli(yE by in(reasin% the prime interest rate a (ountry=s (entral

ban$ (an de(rease in#lation by redu(in% the monetary supply. &nother methodthat (an be used is to de(rease %overnment spendin% and in(rease ta3ationa%ain to redu(e the monetary supply. & third more drasti( method is to institute)a%e and pri(e (ontrols.

!%5% +onetary Policy in Canada

5anada uses t)o $ey (omponents in its monetary poli(y ")ith the %oal bein% lo)and stable in#lation. The #irst (omponent is a #le3ible e3(han%e rate )hi(h allo)sthem to pursue a monetary poli(y that is properly suited to the 5anadiane(onomy. The se(ond (omponent is in#lation (ontrol tar%etin%. In#lation-(ontroltar%etin% has been in pla(e sin(e 77 the aim is to $eep annual in#lation

bet)een 7 and 9< )ith the ideal bein% at 2


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supply the theory is that the hi%her the reserve reuirement the less money theban$ is able to lend out and there#ore the less money is present in the e(onomy.

In#lation (ontrol in 'hana is investi%ated in more detail on se(tion 4.

2.) Inflation and Interest Rates

I# in#lation is risin% the (entral ban$ raises the interest rate meanin% that the (osto# borro)in% in(reases so the amount o# money borro)ed by individuals and(ompanies de(reases )hi(h in turn de(reases the amount o# money in thee(onomymoney supply6 resultin% in de(reased in#lation. The e##e(t o# in#lationon interest rate is simply (aused by the ban$s attempt to redu(e it. On the otherhand in(rease in#lation (auses the (entral ban$ to in(rease interest rate.usinesses then borro) at hi%her (ostE this (ost is pass on to (onsumers )hi(hin(reases (onsumer pri(e inde3 )hi(h in e##e(t in(reases in#lation. elo) is a

paper on in#lation and interest presented by 1udell on *isher and Keynesianar%uments.

1undell ta($led the old *isherian la) on the (onstan(y o# the real rate o# interesti.e. )here r L i - Q )here i# in#lation Q6 rises then nominal interest rate i6 )ill riseone-#or-one to $eep real interest rates r6 (onstant. 0o)ever Keynes 79A6disputed *ishers assertion and *isher 79!6 himsel# )as relu(tant to ma$e toomu(h out o# it empiri(ally.

1undells reasonin% )as as #ollo)s: the nominal rate o# interest is set by in#latione3pe(tations and the real interest rate i L r Q e. Co) suppose )e have t)o

assets money and euity )here r is the real return on euity. y Keynesstheory o# liuidity pre#eren(e money demand is inversely related to the return onalternative assets i.e. r 6. +e $no) o# (ourse that in euilibrium 1Mp L r6 as money supply rises the rate o# interest #alls so )e (an tra(e out anmoney mar$et 116 euilibrium lo(us in interestMmoney supply spa(e as in the*i%ure belo). Co) a parti(ular 11 (urve is (onditional on a parti(ular level o#in#lationary e3pe(tations Qe6. I# in#lationary e3pe(tations rise then #or any %ivenamount o# money supply the real interest rate r L i - Q e #alls and thus the 11(urve shi#ts do)n.

The intuitive lo%i( is that )e must remember that the negativeo# in#lation is the

real rate o# return on money. Thus i# there are in#lationary e3pe(tations a%ents)ho hold money are re(eivin% a ne%ative e3pe(ted return on their real balan(esand thus )ill attempt to %et rid o# them by pur(hasin% euity. &s a result moneydemands #alls and the pri(e o# euity rises - and (onseuently the real rate o#return on euity r and #alls. In the *i%ure belo) )e denote by 11Q eL!6 themoney mar$et euilibrium lo(us )here there are no in#lationary e3pe(tations and11Qe !6 as the money mar$et euilibrium lo(us )hen there is a parti(ularpositive e3pe(ted in#lation rate.

Kris Rasmussen

Daniel Tetteh

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5hart

Suppose no) that in#lationary e3pe(tations are /ero Q eL ! so the 11 QeL !6(urve applies. 'oods mar$et and money mar$et euilibrium implies that )ea(hieve euilibrium , )here money supply is 1Mp!and real and nominal interestrates are eual to ea(h other at i!L r!. +e (an no) tra(e out the (onseuen(eso# an e3o%enous in(rease in in#lationary e3pe(tations. y raisin% in#lationarye3pe(tations to some positive amount Qe ! the 11 (urves shi#ts do)n to 11Qe !6. The ne) euilibrium rate o# real interest r7 is at point * in *i%ure 79)here 11 Q e!6 and interse(t. 0o)ever as no) i L r Q e then a F)ed%eFo# si/e Qeis (reated bet)een the old 11 (urve and the ne) one: the ne) realKris Rasmussen

Daniel Tetteh

1#


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rate r7is read o## the interse(tion o# and the ne) 11 (urve point *6 and thene) nominal rate i7is read o## the top (urve 11 Q eL!6 at the same level o#money supply point '6. Obviously then the introdu(tion o# in#lationarye3pe(tations has in(reased the nominal interest rate #rom i!to i7 but the amounto# the in(rease is lessthan the #ull amount o# e3pe(tations Qe. In other )ords

the real rate o# interest has #allen by lessthan the #ull amount o# in#lationarye3pe(tations. Thus *ishers a) o# nominal interest rates adBustin% to in#lationarye3pe(tations one-#or-one is disabled.

+hat is happenin% intuitively8 & hi%her e3pe(ted rate o# in#lation drove up thenominal rate. This (onseuently made euity more attra(tive relative to money.5onseuently a%ents attempted to %et rid o# their e3(ess money holdin%s bybiddin% up the pri(e o# euity and thus drove the real rate o# return on euitydo)n. This (ollapse in the real rate o# return )ill indu(e more investment but as)e are at a #i3ed level o# output then (onseuently somethin% else must %ive)ay to $eep a%%re%ate demand (onstant - namely (onsumption. +e do this by

brin%in% the money supply do)n #rom 1Mp!to 1Mp7and so by the Pi%ou ,##e(t(onsumption #alls and thus a%%re%ate demand returns to its initial level.

In 'hana those years )here in#lation )as hi%h interest rate on Treasury bill )asalso hi%h. Treasury bill is a ris$ #ree #inan(ial instrument. The ban$s pre#erinvestin% in Treasury bill than borro)in% to businesses be(ause borro)in% tobusinesses has some element o# ris$. Individuals )ho have e3(ess money pre#erTreasury bill than investin% in (ommer(ial a(tivities. This in(reases %overnmentborro)in% and eventually in(reases %overnment e3penditure. +ith %overnmente3penditure in(reased this allo)s e3(ess liuidity in the e(onomy )hi(h in e##e(tin(rease in#lation.

2.* +,c%ange Rate -"rade and Inflation

The e(onomi( bene#its o# trade bet)een nations in %oods servi(es and assetsare similar to the bene#its o# trade )ithin a nation. Trade in %oods servi(es andassets )ithin a nation normally involve a sin%le (urren(y that is dollars yen andpesos and so on. *or e3ample i# an &meri(an resident )ants to pur(hase anautomobile manu#a(tured in South Korea heMshe must #irst trade dollars #or theKorean (urren(y (alled the )on. The Korean (ar manu#a(turer is then paid in)on.

alan(e o# payment and trade balan(e play a $ey role in the determination o#

e3(han%e rate development in a (ountry. alan(e o# payments is a (ountry=sre(ord o# all transa(tions bet)een its residents and the residents o# all #orei%nnations. These in(lude a (ountry=s buyin% and sellin% o# %oods and servi(esimports and e3ports6 and interest and pro#it payments #rom previousinvestments to%ether )ith all the (apital in#lo)s and out#lo)s.The di##eren(e bet)een the value o# %oods and servi(es e3ported and importedis (alled balan(e o# trade. +hen import e3(eeds e3port in a parti(ular (ountrythe reported (ountry is said to have trade de#i(it. +hen (ountry=s e3port e3(eeds

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import the reported (ountry is said to have a trade surplus. In most (ountriestrade balan(e and balan(e o# payment determine the movement o# (urren(y inthat (ountry that is )hether the (urren(y )ill appre(iate or depre(iate.There are three-)ay (lassi#i(ations o# e3(han%e rate. These are pe%%edintermediate #loatin% rates but )ithin a predetermined ran%e6 and #loatin%.

Re%imes (an be (lassi#ied a((ordin% to either the publi(ly stated (ommitment o#the (entral ban$ or the observed behavior o# the e3(han%e rate.Poli(yma$ers have lon% maintained that pe%%ed e3(han%e rate (an be anti-in#lationary tool. In#lation rate is %enerally better under pe%%ed e3(han%e rate. Inthe 7A!s )here most (ountries used the pe%%ed e3(han%e rate e3(han%ein#lation rate )ere lo) indi(atin% a stron% (orrelation bet)een lo) in#lation andpe%%ed e3(han%e rate. 5ountries )ith pe%%ed e3(han%e rate have lo)er rates o#%ro)th in money supply be(ause o# the politi(al (osts o# abandonin% a pe%%edre%ime.

,3(han%e rate is one o# the important e(onomi( poli(y tools. 5han%es in

e3(han%e rate )ere asso(iated )ith in#lation. These are some o# the )ayse3(han%e rate a##e(t in#lationE

+hen the e3(han%e rate depre(iates pri(es o# imported %oods )ould rise. This)ill in e##e(t a##e(t (onsumer pri(es throu%h (osts o# domesti( produ(ers usin%imported inputs. 'hana is a #ree (ountry )ith open trade liberation poli(y. *or somany years no) balan(e o# payment and volume o# trade has been in #avor o#import. 'hana operates the #loatin% e3(han%e rate system.

&lso )hen the e3(han%e rate depre(iates thus in most (ases the (edi depre(iatea%ainst the #orei%n (urren(y the trader need more (edi to buy #orei%n (urren(y)hi(h in(rease the (ost o# imported %oods. The trader passes this (ost to the(onsumer )hi(h in(reases pri(es o# %oods and this (auses (onsumer pri(e inde3to in(rease.

2. /ro!! Dome!tic Product -/DPGross domestic product (GDP) is the total market value of all final goods andservices produced in an economy in one year period. GDP can be calculated intwo ways the e!penditures method and the income method. "hese two methodsare describe into detail below

"#$ $%P$&DI"'R$ PPR*+#,or the e!penditure approach- gross domestic product is eual to the sum of four

e!penditure categories consumption (+)- investment (I)- governmente!penditure (G) and net e!ports (%/0).+*&'0P"I*& 1hen individuals receive income- they can spend it ondomestic goods- save it- pay ta!es- or spend it on foreign goods. "he largest andmost important of the flows is personal consumption e!penditures / payments byhouseholds for goods and services.I&2$"0$& "he saving3investment flow through the financial sector is the

portion of income that individual saves. 4usiness spending on euipment-

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structures- and investments and household spending on new owner/occupiedhousing are counted as part of gross private investment.G*2$R&0$&" $%P$&DI"'R$ Government payments for goods andservices and investment in euipment and structures are referred to as

government e!penditures. "he transfer payments are spentand included in

con!um$tion or !aved and c%anneled to inve!tment.0+" +POR" Individual! !$ending on foreign good! e!ca$e!t%e !#!tem and doe! not add to dome!tic $roduction. $endingon foreign good! im$ort! i! !ubtracted from t%e totale,$enditure!. 0et e,$ort! are e6ual to e,$ort! minu! im$ort!.

"#$ I&+*0$ PPR*+#"he income approach to measuring GDP adds up payments by firms to

households- called factor payments- to arrive at national income (&I)- or totalincome earned by citi5ens and businesses of a country."%e!e a$$roac%e!are de!cribed belo7&OP+08"IO0 O9 +P:O;++ +m$lo#ee com$en!ation-t%e large!t com$onent of national income con!i!t! of 7age!and !alarie! $aid to individual! along 7it% fringe benefit! andgovernment ta,e! for !ocial !ecurit# and unem$lo#mentin!urance.R$&" Rents are the income from property received by households. Rents

received by firms are not included because a firm6s rents are !im$l# anot%er

!ource of income to t%e firm and %ence are cla!!ified a! $rofit!.I&"$R$" Interest is the income private businesses pay to households thathave lent the businesses money- generally by purchasing bonds issued by thebusinesses. Interest payments by government and households aren6t included innational income since by convention they are assumed not to flow the productionof goods and services.PR*,I" Profits are the amount that is left after compensation to employees-rents- and interests have been paid out. 1hen profits are high- firms are doingwell.&I7 +ompensation to employees 8 Rent 8 Interest 8 Profit.

2.16 "%e Relation!%i$ Bet7een Inflation and /DP

In#lation undermines the lon%- run %ro)th prospe(ts o# the e(onomy and(auses #uture levels o# potential in(ome to be lo)er than the other)ise)ould be. Thus #or uantity theorists there is a lon%-run trade-o##s bet)eenin#lation and %ro)th: hi%h in#lation leads to lo)er %ro)th .o) in#lation leads tohi%her %ro)th #or a variety o# reason. o) in#lation redu(e pri(e un(ertainlyma$in% it easier #or businesses to invest in #uture produ(tion. usinesses (an

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more easily enter into lon%-term (ontra(t )hen in#lation is lo) )hi(h lo)est the(ost o# doin% business. o) in#lation also ma$es usin% money mu(h easier.+hen in#lation is hi%h people spend more time tryin% to avoid the (ost o# in#lation)hi(h diverts their ener%ies a)ay #rom produ(tive a(tivities that )ould lead to%ro)th. The hypothesi/ed relationship bet)een in#lation and %ro)th is sho)n in

the dia%ram belo) )ith in#lation on the -a3is and 'ro)th on the U-a3is.

5hart

'ro)th*or uantity theorists %overnment poli(y o# (reatin% an environment o# pri(e-level stability is the poli(y most li$ely to lead to hi%h rate o# %ro)th.On the other hand institutional theory o# in#lation are less sure about thene%ative relationship bet)een in#lation and %ro)th. They a%ree that pri(e-levelrises have the potential o# %eneratin% in#lation and that hi%h a((eleratin% in#lationundermines %ro)th but they do not a%ree that all pri(e level in(reases start anin#lationary pro(ess.

,&R


21/50


2!!9 -4. -74.A -2.!"2!!4 -2.2 -72.7 -7!."2!!; -!. 7.7 79.@

I/T2#(BA/6 +A7-# 0-#2IG/ C3#2/C. #AT2 C-+PA#2'

8IT1 T12 C2'I

-2!!

-7;!

-7!!

-;!

!

;!

7::@ 7::: 2!!! 2!!7 2!!2 2!!9 2!!4

.2A#

'-""A#9P-3/'923#-

RO

CDS


22/50


-@!.!

-A!.!

-4!.!

-2!.!

!.!

2!.!

4!.!

A!.!

7::!

7::7

7::2

7::9

7::4

7::;

7::A

7::"

7::@

7:::

2!!!

2!!7

2!!2

2!!9

2!!4

2!!;

,U50&C',R&T, IC


23/50


& The 2conomies of Ghana and Canada

3.1 /%ana! +conom#

5urrently in the 'hanaian e(onomy In#lationary pressures (ontinue to besubdued )ith prudent #is(al and monetary poli(ies. 1onetary poli(y )as

dire(ted at (ontainin% in#lationE #is(al poli(y )as aimed at stabili/in% and redu(in%the publi( domesti( debt in relation to 'DP. *is(al (onsolidation (ontinued )ithimproved revenue (olle(tion and e3penditure mana%ement and the overall #is(alde#i(it )as redu(ed in line )ith proBe(tions. The balan(e o# payments (ontinuesto improve.

The e(onomy )hi(h hu%ely at the mer(y o# e3ternal sho($ due to the volatility o#the oil mar$et is no) brou%ht under (ontrol. The %overnment too$ a bold de(isionto stop subsidi/in% the o# retail pri(e o# (rude oil in the (ountry. These are someo# the e(onomi( indi(ators )hi(h sho)s positive trend.

3.2 &anada! +conom#5anada=s e(onomy (urrently is in very %ood shape. &s a member o# the '@5anada has sho)n the lar%est %ro)th o# the industriali/ed (ountries )ith theener%y se(tor leadin% the )ay. In#lation has been )ell under (ontrol #or manyyears and borro)in% rates have been #airly lo).

The primary (on(ern (urrently is the value o# the 5anadian dollar 5&D6 )hen(ompared to the >S dollar >SD6 over re(ent months the 5&D has beenapproa(hin% par )ith the >SD )hi(h has the %overnment (on(erned. The(on(ern is that )ith the in(rease in value o# the 5&D or (orrespondin% de(reasein the value o# the >SD6 the (ost o# 5anadian %oods in the >S is in(reasin%

meanin% that there is less demand #or 5anadian %oods e3(ludin% ener%y6. The%overnment is )or$in% to de(rease the value o# the 5&D and is (urrentlydis(ussin% raisin% the prime rate to (ombat this.

3.3 /ro!! Dome!tic Product -/DP

'ross Domesti( Produ(t 'DP6 the total mar$et value o# a (ountrys output o#%oods and servi(es that are e3(han%ed #or money or traded in a mar$et systemover a (ertain period usually a year or a uarter6 re%ardless o# )ho o)ns theprodu(tive assets. 'DP measures the value o# all e(onomi( a(tivity )ithin a(ountry=s borders.

.2A# GhanabillionsG1C;

Canadabillions!


24/50


77 2;"4 ?7@4!;72 9!!@ ?7@9!@79 9@"2 ?7@4"974 ;2!; ?772!7; "";2 ?7A;

7A 7799 ?7"997" 74779 ?2!9;27@ 7"2; ?2!;7 2!;" ?27!!2!!! 2"7;2 ?22@422!!7 9@!"! ?29!7"2!!2 4@@A2 ?29;";2!!9 AA7;" ?29@72!!4 "@@" ?242@92!!; "2A! ?2;7A"2!!A 774!9 ?2;"97

G'P Trend :Ghana;

-2!!!!

4!!!!

A!!!!

@!!!!

7!!!!!

72!!!!

74!!!!

7:@A

7:@@

7::!

7::2

7::4

7::A

7::@

2!!!

2!!2

2!!4

2!!A

.ear

G'P

:billion;

Kris Rasmussen

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G'P Trend :Canada;

?!

?;!!!

?7!!!!

?7;!!!?2!!!!

?2;!!!

?9!!!!

7:@A

7:@@

7::!

7::2

7::4

7::A

7::@

2!!!

2!!2

2!!4

2!!A

.ear

G'P

:billions! day

Interest rate

Interest

#ate79 92.!!< 9;.!!R,IIOC6

R,K,C>,IIOC6

D,*I5ITIIOC6

DO1,STI5D,TIIOC6

The %raphs above sho)s ho) in#lation (han%es )ith %overnment e3penditureand (ertain e(onomi( indi(ators relate )ith e3penditure. & (are#ul study o# the%raphs sho)s ho) in#lation trend (han%e )ith e3penditure. The year )here

e3penditure )as hi%h in#lation also tends to be hi%h. This in e##e(t sho)s a hi%h7 days Treasury bill interest rate indi(atin% e3(essive borro)in% on the part o#the %overnment. *rom 2!!7 )here in#lation seems to be nose-divin% theper(enta%e (han%e in e3penditure )as better than previous years. ,3penditure)as mat(h )ith improved revenue mobili/ation. This put less pressure on%overnmentE in e##e(t redu(e %overnment borro)in% )hi(h have positivedevelopment in Treasury bill rate. This redu(es lendin% rate o# the ban$s to

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borro) to the publi( be(ause Treasury bill rate )as #allin%. This is so be(ause theTreasury bill rate is lo) so the ban$s are #or(ed to borro) to the publi(.

D +ethodology and 2stimation

5.1 et%odolog#

In order to determine the true impa(t o# in#lation o# businesses and trade leastsuares and re%ression models )ere run on histori( data #rom 'hana and5anada.

*urther details on the models used are available in the &ppendi3.

5.2 +!timation

*our models )ere developed to establish best o# %ood #it. The models andrespe(tive analysis is %iven belo):

+odel Ghana;Dependent ariable: IC*&TIOC1ethod: east SuaresDate: !AM7AM!" Time: 29:!9Sample: 7@A 2!!AIn(luded observations: 27

ariable 5oe##i(ient

Std. ,rror t-Statisti( Prob.

5 742.A@7 7!A.49@9 7.94!;@! !.7""O''DP6 -74.@2!@ 72.@24;7 -7.7A722! !.2A7A

O',U50&C',6 74.4!97A 74.;7!49 !.2A!" !.994@ICT,R,ST !.;"997! !.9A94A9 7.;""9;4 !.7997

R-suared !.9A"A2" 1ean dependent var 2;.;;24&dBusted R-suared !.2;A!97 S.D. dependent var 74.!@@2"S.,. o# re%ression 72.7;7A; &$ai$e in#o (riterion @.!!244Sum suared resid 2;7!.2A2 S(h)ar/ (riterion @.2!74!Ao% li$elihood -@!.!2;"2 *-statisti( 9.242@ADurbin-+atson stat 7."4!;2" Prob*-statisti(6 !.!4;@;

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5hart

-2!

!

2!

4!

!

2!

4!

A!

@!

@A @@ :! :2 :4 :A :@ !! !2 !4 !A

Residual &(tual *itted

The Re%ression #or this model is %iven belo):

IL 5V7lo%6 V2lo% ,6 V9R )hereIL In#lationL 'DP at (urrent pri(e,L,3(han%e rate o# the (edis a%ainst the dollar5L 5onstant andV L (oe##i(ient o# the independent variables

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In the model 7 above R2L 9A.@ )hi(h is less and does not sho) a %ood o# best #it#or the re%ression. The nominal data su(h as 'DP at (urrent pri(e e3(han%e rate o#the 'hanaian (edis a%ainst the dollar are e3pressed in natural lo%. The (oe##i(ientso# the model above are not %ood enou%h #or the re%ression i# )e should do any#ore(ast. The *-statisti( is lo) althou%h the probability o# *-statisti( is %ood #or the

re%ression be(ause is nearin% /ero. This model sho)s that the relation bet)eendependent variable In#lation6 and the independents variables 'DP ,3(han%e rateand interest rate6 is not stron% enou%h. This model is reBe(ted and la% is introdu(edin the se(ond model belo).

+odel !; Ghana

Dependent ariable: IC*&TIOC1ethod: east SuaresDate: !AM7AM!" Time: 29:!"SampleadBusted6: 7@" 2!!AIn(luded observations: 2! a#ter adBustin% endpoints

ariable 5oe##i(ient Std. ,rror t-Statisti( Prob.

5 -4!A.7@A@ 792.!@4! -9.!";27; !.!!AO''DP6 2;.7;; ;4.2"44A ;.4;22!; !.!!!7

O',U50&C',6 4.@!2"@2 74.!A"4; !.947477 !."9@"ICT,R,ST !.977; !.99AA2 !.2A"7A !.9"29

IC*&TIOC-76 -!.A@@44@ !.297A@@ -2."74;7 !.!77"O''DP-766 -2;4.74AA 49.!A@A@ -;.!!A! !.!!!7

O',U50&C',-766 -4.!A!@ 7".!792; -2.@@9A2 !.!79"ICT,R,ST-76 !.;;2!9; !.94AA;! 7.;24@; !.79"9

R-suared !.@A!;77 1ean dependent var 2;.27!!!&dBusted R-suared !.""742 S.D. dependent var 74.94!99S.,. o# re%ression A."997! &$ai$e in#o (riterion A.42A"Sum suared resid ;4;.!7A S(h)ar/ (riterion ".9472;o% li$elihood -A7.42A" *-statisti( 7!.;";4"Durbin-+atson stat 2.4A!! Prob*-statisti(6 !.!!!2A"

5hart

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-7!

-;

!

;

7!

7;

!

2!

4!

A!

@!

@@ :! :2 :4 :A :@ !! !2 !4 !A


The re%ression #or this model is %iven belo):

IL 5V7lo% -766 V2lo% , -766 V9R -76

In the se(ond model all the variables In#lation 'DP ,3(han%e rate and Interestrate6 )ere la%%ed. ter the end points )ere adBusted model 2 sho)s a best%ood o# #it. R-Suared is @A.7< and adBusted R-Suared is "".


41/50


ICT,R,ST !.49"7@! !.77!4 9.4!9;@ !.!!77

R-suared !.A!@4;2 1ean dependent var 2.A;"749&dBusted R-suared !.;99;; S.D. dependent var 7.4494;@S.,. o# re%ression !."A@" &$ai$e in#o (riterion 2.AA4"ASum suared resid 7A.97A9" S(h)ar/ (riterion 9.7A;499o% li$elihood -2".74@!! *-statisti( @.@!;";Durbin-+atson stat 7.@A;7@ Prob*-statisti(6 !.!!!;A

5hart

-2

-7

!

7

2

9

!

2

4

A

@A @@ :! :2 :4 :A :@ !! !2 !4 !A


The sample re%ression #or the above model isEIL 5 V7lo%6 V2lo% ,6 V9R

In the model 9 above R2L A!.@< and adBusted R-Suared is ;9. these #i%uressho) a %ood #it #or the re%ression but not hi%h enou%h #or a stron% relationshipbet)een the dependent variableIn#lation6 and the independent variables'DP,3(han%e rate interest rate6. The nominal data su(h as 'DP at (urrent pri(ee3(han%e rate o# the 5anadian dollar a%ainst the >S dollar are e3pressed innatural lo%. The (oe##i(ients o# the model above are %ood enou%h #or there%ression i# )e should do any #ore(ast. The *-statisti( is %ood althou%h theprobability o# *-statisti( is %ood #or the re%ression be(ause is nearin% /ero. Thismodel sho)s that the relation bet)een dependent variable In#lation6 and theindependents variables 'DP ,3(han%e rate and interest rate6 is %ood enou%h.+e e3plore #urther by introdu(in% la% in the estimation euation.

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+odel ) CanadaDependent ariable: IC*&TIOC1ethod: east SuaresDate: !AM7AM!" Time: 22:;!SampleadBusted6: 7@" 2!!AIn(luded observations: 2! a#ter adBustin% endpoints

ariable 5oe##i(ient

Std. ,rror t-Statisti( Prob.

5 -42.72"!; 24.!@"4; -7."4@27 !.7!;@O',U50&C',6 7!.492@7 9.9;4"A 9.7!@4; !.!!!

O''DP6 -!.27@9@! 79.7";!2 -!.!7A;"; !.@"!ICT,R,ST !.7992 !.!442 7.4!7"9@ !.7@A9

IC*&TIOC-76 -!.!@""42 !.7A!";4 -!.;4;@7" !.;;2O',U50&C',-766 -72.9"24! 9."2"2A -9.97"247 !.!!A7

O''DP-766 4.24997 72.2@A !.94;9;A !."9;@ICT,R,ST-76 !.494"; !.7;9442 2.@99A!; !.!7;7

R-suared !.@7;"! 1ean dependent var 2.;@;!!!&dBusted R-suared !.@2@92! S.D. dependent var 7.447;7S.,. o# re%ression !.;"979 &$ai$e in#o (riterion 2.!A429Sum suared resid 4.2@794 S(h)ar/ (riterion 2.44"7Ao% li$elihood -72.A429 *-statisti( 74.!;@;

Durbin-+atson stat 2.@4@2;2 Prob*-statisti(6 !.!!!!A4

5hart

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-7.;

-7.!

-!.;

!.!

!.;

7.!!

2

4

A

@@ :! :2 :4 :A :@ !! !2 !4 !A


IL 5V7lo% -766 V2lo% , -766 V9R -76

In the se(ond model all the variables In#lation 'DP ,3(han%e rate and Interestrate6 )ere la%%ed. ter the end points )ere adBusted model 4 sho)s a best o#%ood #it. R-Suared is @.2< and adBusted R-Suared is @2.@


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5 Conclusions

5anada is a developed (ountry and 'hana is a developin% (ountry. In both(ountries there seems to be a stron% relationship bet)een in#lation as adependent variable and 'DP ,3(han%e rate and interest rate as independentvariable )hen the data is la%%ed. 5anada=s model 9 has a %ood #it even )ithoutthe data bein% la%%ed and is stron%er i# all the variables are la%%ed. This reallysho)s the impa(t o# 'DP ,3(han%e rate and interest rate on in#lation. In other)ords national in(ome 'DP6 ,3(han%e rate trade6 and interest rate

businesses6 play $ey role in determination o# in#lation.

Returnin% to the uestions that )ere posed at the be%innin% o# the paper:

76 +hat is the impa(t o# in#lation on businesses and trade8

ased on the results o# the statisti(al analysis that has been per#ormed in(reasesin in#lation appear to have an adverse e##e(t on 'DP. There#ore it (an be(on(luded that hi%h in#lation has an adverse e##e(t on business and trade.

26 1ost businesses depend on loans to run their business operations. +hat

is the (orrelation bet)een in#lation and interest rate both in 'hana and5anada8

oth 5anada and 'hana use interest rate settin% in their monetary poli(y in ane##ort to redu(e the money available in the e(onomy and there#ore minimi/ein#lation. There#ore there is an obvious (orrelation bet)een an in(rease inin#lation and a (orrespondin% in(rease in interest rate in order to (ontrol in#lation.

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96 0o) is in#lation a##e(tin% the e3(han%e rate development o# import ande3port8 +hat is the e##e(t on businesses that depend mostly on importedra) material #or produ(tion8

*rom the models above there appears to be a (orrelation bet)een in#lation andthe e3(han%e rate o# the (ountry )hi(h have adverse e##e(t on trade thus importand e3port. 1ost (ountries no) used #loatin% e3(han%e. +hat this means is thatbusinesses )hi(h rely heavily on imported ra) material #or produ(tion )ill haveto pray #or a stable (urren(y. >nstable (urren(y )ill in(rease (onsumer pri(einde3 )hi(h a##e(t pur(hasin% po)er in an e(onomy. On (omparative analysis o#both (ountries 5anada seems to have a very stable (urren(y. This has a##e(tedboth their import and e3port positively. 'hana on the other hand has unstable(urren(y. alan(e o# payment is al)ays in #avour o# import )hi(h have ane%ative e##e(t on our (urren(y.

46 0o) is monetary poli(y used in 5anada to (ontrol in#lation and ho) doesthis (ompare to the poli(y bein% used in 'hana8

&s dis(ussed earlier 5anada relies on settin% a prime interest rate in an e##ort toredu(e money supply thereby (ontrollin% in#lation. This method (oupled )iththeir in#lation rate tar%etin% has been very su((ess#ul in (ontrollin% in#lation sin(eit )as #irst adopted. 'hana on the other hand relies on both an interest ratesettin% as )ell as a reserve reuirement poli(yE they have had less su((ess intheir e##orts to (ontrol in#lation in the e(onomy. The bi%%est reason #or this la($o# su((ess is the (ommer(ial ban$s un)illin%ness to #ollo) the an$ o# 'hana=sinterest rate )hen settin% lendin% rates. +hat this means is that mu(h o# theban$=s e##orts )hen it (omes to interest rate settin% is ine##e(tive. The reason #orthe relu(tan(e in the ban$s to #ollo) the (entral ban$=s %uidan(e on interest ratesundoubtedly is a result o# the la($ o# (ertainty in )hat the short and lon% termin#lation rates may be. There#ore businesses #ind it di##i(ult to a((ess (redit #ore3pansion espe(ially small s(ale industries.

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E =ources

7. +ilson 'eor%e +. In#lation 5auses 5onseuen(es and 5ures. 7st ed.loomin%ton IC: Indiana >niversity Press 7@2.

2. The &meri(an 0erita%e Di(tionary o# the ,n%lish an%ua%e. 4thed.0ou%hton 1i##lin 5ompany 2!!!.

9. Thomas +ilson In#lation 5ambrid%e 1&: 0arvard >niversity Press 7A7.4. F5osts o# In#lationF +orld ,(onomi( Outloo$ 7A;. an$ o# 'hanaA. an$ o# 5anada". 'hana Statisti(al Servi(e@. ,-vie)s ))).evie)s.(om6

. G1onetary Poli(y ReportH an$ o# 5anada 2!!"7!. G1onetary 1ana%ement in 'hanaH an$ o# 'hana 2!!777. 1a(roe(onomi(s *ourth ,dition6 by David 5. 5olander.72.Prin(iples o# ,(onomi(s by Robert *ran$ and en ernan$e.79.'hana=s ud%etary statement #or 2!!4.

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F Appendi4

The #egression 0unctionThe estimated re%ression relationship is as #ollo)sE

L V! V7U7V2U2WWW..VnUn )here

is the dependent variableV is the (oe##i(ient o# the independent variablesU is the independent variable

In usin% ,-vie)s #or the estimation o# the model ea(h estimated (oe##i(ient hasan asso(iated standard error )hi(h is the estimated standard deviation a

measure o# the pre(ision o# the estimator. ,a(h estimated 5oe##i(ient also has anasso(iated t-Statisti(E this is the ratio o# the (oe##i(ient to its standard error. Thisstatisti( is used to test the hypothesis that the (orrespondin% parameter is eualto /ero. The t-Statisti( #ollo)s a Student=s t-distribution )ith de%rees o# #reedomeual to the sample si/e minus the number o# parameters estimated K6.

I# the hypothesis $L!V6 is true then the t-statisti( probably lies (lose to /eroEother)ise it is li$ely to #all in one o# the tails o# the distribution. +hether a(al(ulated t-statisti( is statisti(ally di##erent #rom /ero is determined by (omparin%it )ith a (riti(al value #or the t-distribution #or a pre-sele(ted si%ni#i(ant level.0!: V$L !

07: V$X !De(ision rule: i# abs t-statisti(6t(rit then reBe(t the null hypothesis

Probability: is the probability that the student=s random variable lies #urther in thetail o# the distribution than the (al(ulated t-statisti( #or the (oe##i(ient does. Thisvalue (an also be used to test the hypothesis %iven above. This is an easierapproa(h and produ(es e3a(tly the same de(ision as the previous de(ision rule:De(ision Rule: I# ProbY then reBe(t Z

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R-Suared R26 is the G%oodness o# #itH measure. It measures the proportion o#variation in the dependent variable that is Ge3plainedH by the sample re%ression#un(tionE it measures the de%ree to )hi(h the data lie G(loseH to the line. This isuite distin(t #rom the slope o# the line.

The Adjusted #!

(ontains a de%rees o# #reedom (orre(tion that a((ounts #or theestimation o# additional parameters. &ddin% independent variables adds morestatisti(al in#ormation than is (onsumed by the additional (oe##i(ients then theadBusted R2in(reases.

Sum Suared resid SSR6 is [et2. SSRM T- K6 is estimator o# the error varian(e Zand the suare root o# this estimator is $no)n as the standard error o# there%ression S, re%ression6.

o% li$elihood is the lo%-li$elihood #un(tion #or normally distributed sto(hasti(disturban(es6 evaluated at the estimated (oe##i(ient values. It is (al(ulated as

\L -T ]7lo% 2Q6 lo% [et26^2 T

0ypotheses may be tested via li$elihood ratio tests that (ompare the lo%-li$elihood values #or restri(ted i.e. imposin% the null hypothesis6 and unrestri(tedeuations.

'urbin(8atson stat:is desi%ned to dete(t #irst-order serial (orrelation o#residuals.1ean Dependent varL _S.D dependent var is the sample standard deviation o# the dependent variable.

Akaike info criterionis %iven by

&I5 L 2K-`6 TSmaller values o# &I5 are pre#erred.

=chwar criterion is similar to &I5 but imposes a stron%er penalty #or estimatin%additional parameters in the model. It is %iven by

S5L Klo% T6-2`6 T

0(=tatisticis used to test the hypothesis that the e3planatory po)er o# the modelis /ero. The null and alternative hypotheses are:

0!:V2LV9L WWWL $L!07: Cot all slope (oe##i(ients are /ero

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>nder the null hypothesis and )ith statisti(ally independent iid normal sto(hasti(disturban(es6 the *-statisti( #ollo)s an *-distribution )ith K-76 numeratorde%rees o# #reedom and T-K6 denominator de%rees o# #reedom lar%e values o#the *-statisti( lead us to reBe(t the null hypothesis. This *-test is an e3ample o# a+ald test.

De(ision Rules: &s )ith the t-statisti( )e (an #ormulate de(ision rules #or the *-statisti( in terms o# (riti(al values dra)n #rom the *-distribution.2stimating and Testing a =imple Time(=eries +odelThe 'eterministic "og("inear; Time Trend +odel

& traditional method #or estimatin% the lon%-term trend in a data series tis are%ress the lo%arithm o# ton the inter(ept and time trend.

o% t6 L V7V2 ct

The (oe##i(ient is the trend %ro)th rate in . The sto(hasti( errors are stationaryE

this model is o#ten (alled the trend stationary TS6 model.

The 'urbin(8atson =tatisticThe Durbin-+atson is desi%ned to test #or #irst-order auto(orrelation )hen there%ression (ontains an inter(ept term and )hen it does not (ontain any la% o# thedependent variable as a re%ressor. >nder the null hypothesis o# no #irst-orderauto(orrelation the D+ statisti( is eual to 2E values (lose to ! reBe(t the null in#avor o# positive auto(orrelation and values (lose to 4 reBe(t the null in #avor o#ne%ative auto(orrelation.

Autocorrelation and Partial Autocorrelation 0unctions5onsider the &uto(orrelation &56 #un(tion:

T [etet-$ r$L tL$L7 T [ et2

tL7

This is the estimated auto(orrelation (oe##i(ient #or $ la%s. The hypothesis thatthere is no auto(orrelation up to order $ (an be tested usin% the Bun%-o3 -Statisti(:

$ L T T26 [ rB2 iL7 T-B6

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>nder the null hypothesis o# no auto(orrelation the statisti( is asymptoti(allydistributed as )ith $ de%rees o# #reedom.

Partial &uto(orrelations are estimated #rom the re%ression etL7et-7 2et-2W.$et-$vt

The (oe##i(ients measures the (orrelation bet)een residuals that are B periodsapart (ontrollin% #or the (orrelations at other la%s.

Thesis Project - Rasmussen-Tetteh - 072407

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