Debt Servicing, Exchange Rate Depreciation, and Inflation in Ghana: Evidence from ARDL Bounds Testing and NARDL Asymmetric Analysis
This study utilizes ARDL and NARDL frameworks to analyze Ghana's 1993–2024 data, revealing that while structural breaks limit long-run cointegration, public debt servicing negatively impacts inflation through demand crowding-out, whereas exchange rate movements symmetrically drive inflation and GDP growth dampens it.
Original paper licensed under CC BY 4.0 (https://creativecommons.org/licenses/by/4.0/). This is an AI-generated explanation of the paper below. It is not written or endorsed by the authors. For technical accuracy, refer to the original paper. Read full disclaimer
Imagine the economy of a country like a giant, bustling kitchen. In this kitchen, the price of a meal (inflation) isn't just about how much the chef charges; it's about how much the kitchen owes to the bank (debt), how much the value of the local currency is worth compared to the dollar (exchange rate), and how fast the kitchen is actually cooking up new food (economic growth). For decades, economists have argued about what happens when the kitchen owes too much. One theory, the "Fiscal Theory," suggests that if the debt gets too high, the government might just print more money to pay it off, causing prices to skyrocket like a balloon popping. Another theory, the "Crowding-Out" idea, suggests that if the kitchen spends all its cash paying off old loans, it has no money left to buy fresh ingredients, so it cooks less, and prices might actually cool down. Understanding which of these forces is stronger is crucial because if a country gets its math wrong, the cost of bread, fuel, and medicine can spiral out of control, hurting everyone from the poorest family to the richest business.
This paper takes a deep dive into the kitchen of Ghana, a country in West Africa, to see how its debt, its currency, and its growth have interacted with inflation between 1993 and 2024. The researchers, Isaac Nyame and Gabriel Osei Forkuo, didn't just look at the total amount of debt; they separated the "stock" of debt (the total bill) from the "servicing" (the actual cash flow needed to pay interest and principal each year). They used a sophisticated statistical toolkit called ARDL and NARDL, which are like high-powered microscopes that can spot patterns even when the data is messy or has sudden jumps, like when a country changes its currency or faces a crisis. They also checked if the relationship between the currency getting weaker (depreciation) and prices going up was one-way, or if it acted differently when the currency got stronger (appreciation).
Here is what they found in the Ghanaian kitchen. First, they discovered that the idea that high debt payments automatically cause the government to print money and create hyperinflation might not be the whole story for Ghana. Instead, their data suggests a "crowding-out" effect: when the government has to spend a huge chunk of its budget just to service its debt, it has less money to spend on other things. This reduction in spending actually seems to dampen inflation, acting like a brake rather than a gas pedal. In their models, a higher debt-servicing bill was linked to a lower inflation rate, suggesting that the pressure to pay off debts is currently squeezing out the spending that usually drives prices up.
Second, the study looked at the exchange rate, which is the price of the Ghanaian Cedi against the US Dollar. They found a very strong, clear link: when the Cedi loses value (depreciates), inflation goes up. This makes sense because Ghana imports a lot of its food and fuel, so a weaker currency makes those imports more expensive. However, the researchers also tested a tricky question: does the currency act differently when it gains value (appreciates)? They found that while depreciation definitely pushes prices up, appreciation doesn't seem to push prices down as much as you might expect. In fact, the data showed that even when the currency gets stronger, inflation still tends to rise, though the difference between the two effects wasn't statistically huge. The authors suggest this is because when the currency gets strong, it often happens during times of global commodity booms (like high oil or gold prices), which bring in more money and heat up the economy, offsetting the cooling effect of a stronger currency.
Third, the paper highlights that economic growth is a powerful stabilizer. Whenever Ghana's economy grew faster, inflation tended to go down. It's like when a kitchen suddenly gets a massive new oven; it can cook more food to meet demand, so the price of the meal doesn't have to jump. This was one of the most consistent and reliable findings in their study.
However, the researchers are careful not to claim they have solved the mystery completely. They admit that with only 32 years of data and so many major crises (like the 2007 currency change and the 2022 debt crisis), it's hard to prove a perfect, unbreakable long-term rule. Their statistical tests were "inconclusive" on whether a stable, long-term equilibrium exists, meaning the relationship is a bit shaky and sensitive to these big historical events. But the "error correction" part of their math—which measures how fast the economy snaps back to a normal state after a shock—was very strong, suggesting that despite the chaos, the economy does try to find its balance.
In short, the paper suggests that for Ghana, paying off debt might actually help keep prices down by limiting government spending, while a weak currency is a major driver of high prices. The study also warns that simply looking at the total debt isn't enough; you have to look at the cash flow needed to pay it. While the results are promising, the authors urge policymakers to be careful: fixing the debt might free up money for spending, which could actually increase demand and inflation if not managed well. The key takeaway is that keeping the currency stable and encouraging economic growth are the most reliable tools for keeping the price of a meal affordable in the Ghanaian kitchen.
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