According to (Mishkin & Schmidt-Hebbel, 2007) this tool is so popular because it has a proven track record of creating macroeconomic stability. The authors explain that this stability is present because it promotes price stability. The authors further explain that even
"though the contribution of it to lowering inflation is still a matter of debate, empirical research suggests that it has significantly contributed to lowering inflation and its volatility, especially in emerging markets. Secondly, empirical evidence suggests that it has also improved other macroeconomic variables
(lower output sacrifice ratio, decreased influence of price shocks and output shocks on inflation, smaller inflation persistence. Thirdly, it has facilitated stabilization of long-term inflation expectations, thus reducing the cost of maintaining low inflation (Mishkin & Schmidt-Hebbel, 2007)."
The authors further insists that while inflation targeting was not the only strategy at work in the promotion of price stability and lower inflation, it has certainly been a major factor in many economies (Mishkin & Schmidt-Hebbel, 2007). In fact the Governor of the Bank of England Mervyn King inflation targeting has been successful because it reduces costs associated with decision making. Although inflation targeting has proven to be successful there are still certain questions that remain as it pertains to the use of such a strategy as a monetary policy. The first question involves whether or not inflation targeting should be strict or flexible (Mishkin & Schmidt-Hebbel, 2007). Strict or flexible inflation targeting a way of integrating output and employment fluctuations into monetary policy decisions. Many economists including Lars Svenson believe that "all real-world inflation targeting is flexible inflation targeting"(Mishkin & Schmidt-Hebbel, 2007). This simply means that concerns about output (and employment) are normally evident in the decision-making process (Mishkin & Schmidt-Hebbel, 2007). The authors also explain that even though many central banks believe that there should be limits placed on output and employment fluctuations in the development of the policy, central bankers do not agree on how to incorporate such limits into policy (Mishkin & Schmidt-Hebbel, 2007).
Another issue that makes inflation targeting attractive is the possibility of in research communication and transparency (Mishkin & Schmidt-Hebbel, 2007). Many economists recognize that communication is the main conduit through which central bank's are able to have a positive impact on the economy because they are able to better manage expectations through communication and transparency (Mishkin & Schmidt-Hebbel, 2007). According to Lars Svensson the current level of central bank interest rates is not extremely relevant for the purposes of determining future inflation and economic activity (Mishkin & Schmidt-Hebbel, 2007). In addition Michael Woodford asserts that apart from expectations, not much else is relevant (Mishkin & Schmidt-Hebbel, 2007). Because this is the case inflation targeters place larger significance on the ability to communicate effectively (Mishkin & Schmidt-Hebbel, 2007). The authors further explain that
"Useful tools for it are decision statements, inflation reports, published inflation forecasts and central bankers' public speeches. These tools are now standard in communication among the best it-performers. For central banks from emerging markets applying these standards is very desirable, as in this way they can gain
some 'confidence premium' from the market, who perceive such central banks as 'good practice' followers. This is very important especially amid growing internationalisation of financial markets, when interpreting central bank's policy is much easier under standard communication. Surely, it is not the amount of communication that matters but rather its quality. This refers especially to central bankers' talk. It is more important, what you say than how you say it as unclear signals may actually misguide the market (Mishkin & Schmidt-Hebbel, 2007)."
Indeed, the introduction and implementation of inflation targeting into an economy can be critically important to improving the overall stability of the economy and even the political stability of the country. Such stability is important because it encourages growth, development and improvement to the standards of living for citizens. In addition, the implementation and development of inflation targeting into economic strategy encourages greater transparency and communication. This communication is important for the government which oversees the overall stability of the country and also fir the citizens of the country. When government leaders such as legislatures have a clear understanding of the policies that govern the economy they can make better decisions about other policies that may also have an impact of the economy. For the nation of Ghana such regulations are needed to secure the financial future of the country.
Ghana and emerging economies throughout the world face the challenge of stabilizing inflation so that the economy can flourish. In Ghana high inflation rates were impeding upon the ability of the nation's economy to expand. Inflation targeting is a tool that can be utilized in an effort to make inflation rates more predictable over time. The ability to make inflation rates stable over time is essential to economic growth because it stabilizes prices, encourages investment and secures employment opportunities. Additionally, Monetary Management by the Central Bank as a major arm of economic policy management in Ghana has by law and practice often focused on price stability.
Yet over the years in Ghana, monetary policies implemented by the central bank has had a history of strong inflationary pressures from a triple digit in the early seventies and eighties to double digits in the nineties and is currently battling to attain single digit. Even, the strict monitoring of fiscal and monetary aggregates under the International Monetary Fund/World Bank sponsored Structural Adjustment Program (SAP) could only yield an average inflation of about 25% p.a between 1986 and 2000. Clearly inflation continues to be a major problem for policy makers in Ghana.
Objective of the Study
The study proposes to reveal the effectiveness of Inflation Targeting as a policy tool in managing inflation by the Central Bank. The study will also explain why in the face of falling interest rates the Ghanaian Central Bank still achieves its desired objectives of lower rate of inflation. The study will specifically provide information on inflation management in Ghana prior to the establishment of MPC and post establishment of the MPC to determine any significant change in parameters. Studies on inflation targeting in general have been done by renowned economist like Frederic Mishkin et al., Nii Kwaku Sowa, (to mention a few) however my studies focuses on the inflation targeting strategy adopted by Central bank of Ghana.
The methodology will involve the use of time series data taken from a sample period between 1972 and 2008. This data will be collected and analyzed. Data sources shall include among others, MPC reports, national budgets and publications from the research department of BOG. The data collected will be divided into two sub-samples, that is, regime before the establishment of MPC and post MPC era. Using the following money demand model,
Md = P* L (R, Y)
Where Md is amount of money demanded, P is the price level, R is the nominal interest rate and Y is real output.
The data will be tested to determine the stability of money demand function over the two eras.
The study will also draw conclusion based on the use of secondary research. This research will be derived from books, journals, reports published by the Bank of Ghana, the government and the International Monetary Fund.
Limitation of Study
As a result of the time constraint and difficulty in obtaining economic data, this study will be restricted to the period between 1972 and 2009. Additionally, the study is limited in that the official adoption of the MPC and inflation targeting has been relatively recent.
Relevance of Study
This study is significant because it will allow central banks in other countries to review the use of inflation targeting as a monetary policy in Ghana. Through this analysis emerging markets will have a better understanding of how this monetary tool works and whether or not it is a tool that is effectual for the purposes of lowering and stabilizing the rate of inflation. Within the Ghanaian context some in the business community belong to the school of thought that Inflation Target leads to the increase of interest rate and consequently the cost of doing business in the Ghana. This is evidence by the stated position of the Association Ghana Industries' negative reaction to the MPC's decision to raise the prime rate from 17% in December 2007 to 18.5% in February 2008. In undertaking this study, it is expected that the findings would prove the usefulness of Inflation Targeting as a good monetary policy tool in enhancing output and invariably lowering inflationary pressures. The findings of this study will bring both the Central Bank and the business community together in the pursuant to attain price stability
The research questions for this discussion are as follows,
1. Why did Ghana adopt an inflation targeting strategy?
2. Were there any significant changes in parameters for inflation management in Ghana prior to the establishment of MPC…