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The Monetary Policy Rate and Inflation in Ghana: A Bayesian DSGE Approach to the New Keynesian Theory

This paper employs a Bayesian DSGE model grounded in New Keynesian theory to analyze Ghana's monetary policy, revealing that while the Central Bank responds aggressively to inflation with significant transmission lags, the economy is characterized by highly impatient households and a strong link between economic activity and inflation.

Original authors: Dennis Nchor

Published 2026-09-08

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CC BY 4.0

Original authors: Dennis Nchor

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

In the complex machinery of a modern economy, the central bank acts as the thermostat, constantly adjusting the temperature to keep things from getting too hot or too cold. When prices for goods and services rise too quickly, a condition known as inflation, the purchasing power of money erodes, making life harder for families and businesses. To cool things down, central banks typically raise the cost of borrowing money, a lever known as the monetary policy rate. The theory is straightforward: if borrowing becomes expensive, people and companies spend less, demand drops, and prices stabilize. However, this mechanism relies on a delicate chain of trust and reaction. It assumes that when the central bank turns the dial, commercial banks will immediately follow suit, and that households will instantly change their spending habits. In many developing nations, this chain is often broken or sluggish, leaving policymakers wondering if their primary tool is actually working.

A recent study by economist Dennis Nchor at Mendel University Brno dives deep into this question, focusing specifically on Ghana, a nation that has historically battled wild swings in prices. The research uses a sophisticated computer simulation, a type of economic model that mimics how different parts of the economy interact over time, to test how effective Ghana's central bank has been at controlling inflation. The study looks at data spanning two decades, from 2006 to 2026, to see if the central bank's actions actually translate into lower prices and if the economy responds as expected. The findings reveal a picture of a central bank that is aggressive and responsive, yet hampered by the unique realities of a developing economy where people are often forced to live for the present rather than planning for the future.

The researchers found that the Bank of Ghana is indeed highly sensitive to rising prices. When inflation climbs, the central bank reacts swiftly and forcefully. The data suggests that for every single percentage point that inflation rises, the central bank raises the monetary policy rate by more than two percentage points. This indicates a determined effort to keep prices in check, often described as an aggressive stance. The simulation shows that this strategy does work, but not immediately. When the central bank raises rates, it takes time for the effects to ripple through the economy. The study estimates that it takes between seven and thirteen months for these rate hikes to successfully lower inflation. Similarly, it takes between three and seventeen months for the economy's overall output to feel the impact of these tighter policies. This delay is a crucial detail, reminding policymakers that the results of their decisions are not instant but unfold over the course of a year or more.

However, the study also uncovers a significant hurdle in how the economy functions. The model suggests that households in Ghana are extremely present-oriented. In the language of economics, this means they heavily discount the future, valuing immediate consumption far more than saving for later. This behavior is driven by the reality that many people lack access to reliable financial institutions or face tight budget constraints, making it difficult to plan ahead. Because people are so focused on the here and now, they are less likely to change their spending habits just because borrowing costs have gone up. Furthermore, the study highlights a persistent problem with the banking system itself. There is a wide gap, or spread, between the rates banks charge for loans and the rates they pay to savers. While the central bank might lower its policy rate to encourage borrowing, commercial banks are often slow to pass those savings on to customers. Instead, they keep lending rates high to protect their own profits, which weakens the central bank's ability to stimulate the economy.

The results of this analysis paint a nuanced picture of monetary policy in Ghana. The central bank is not inactive; it is actively and aggressively fighting inflation, and its actions do eventually lead to lower prices. Yet, the path to stability is long and winding. The transmission of policy is slow, taking up to a year to fully take effect, and the mechanism is often clogged by structural issues like high borrowing costs and a population that must prioritize immediate survival over future planning. The study concludes that for monetary policy to be truly effective, the central bank must do more than just adjust rates. It must also work to ensure that commercial banks actually lower their lending rates when the central bank cuts them, and that the gap between what banks charge and what they pay savers becomes fairer. Without addressing these underlying frictions, the central bank's powerful tool may continue to struggle to reach the people and businesses it is designed to help.

Technical Summary: The Monetary Policy Rate and Inflation in Ghana

Problem Statement
The paper addresses the persistent volatility of inflation in Ghana and questions the effectiveness of the Monetary Policy Rate (MPR) as a market signaling tool for price stability. Despite the Bank of Ghana's transition to an Inflation Targeting regime in 2007, the central bank has frequently missed its single-digit inflation targets due to structural rigidities, fiscal deficits, exchange rate volatility, and external supply shocks. A critical concern is the weak interest rate pass-through, where commercial banks fail to adjust lending rates in response to MPR changes, and the high cost of borrowing which crowds out private sector activity. The study seeks to empirically assess two primary questions: (1) Is the Central Bank of Ghana responsive to inflation fluctuations? and (2) Is the MPR an effective tool for controlling inflation within the Ghanaian economy?

Methodology
The study employs a Bayesian Dynamic Stochastic General Equilibrium (DSGE) model grounded in New Keynesian theory, specifically incorporating nominal rigidities and limited asset market participation. The analysis utilizes monthly data from the Bank of Ghana spanning from February 2006 to February 2026.

The model structure consists of three core equations:

Investment-Savings (IS) Function: Links the output gap to expected future output, the real interest rate, and expected inflation. The output gap is treated as an unobserved variable.
New Keynesian Phillips Curve: Connects current inflation to expected future inflation and the current output gap, incorporating a discount factor ( $\beta$ ) and a price adjustment parameter ( $\kappa$ ).
Taylor Rule: Describes the Central Bank's reaction function, relating the current interest rate to its lagged value and current inflation, governed by a smoothing parameter ( $\rho_r$ ) and an inflation response coefficient ( $\delta$ ).

The estimation utilizes the Bayesian approach with Markov Chain Monte Carlo (MCMC) sampling (Metropolis–Hastings algorithm) to minimize absurd parameter estimates often found in pure likelihood estimation. Priors are specified based on the economic context of a developing economy, such as a high discount rate for households due to limited financial access. The model includes autoregressive processes for monetary and real shocks.

Key Results
The Bayesian estimation yields the following posterior means and insights:

Household Behavior: The posterior mean for the discount factor ( $\beta$ ) is 0.95, indicating that households are extremely present-oriented, highly impatient, and heavily discount future consumption. This reflects high liquidity constraints and low financial inclusion.
Inflation Sensitivity: The parameter $\kappa$ (kappa) has a posterior mean of 0.36, revealing a relatively high responsiveness of inflation to economic activity (the output gap), consistent with the New Keynesian Phillips Curve in developing economies.
Central Bank Responsiveness: The posterior mean for the Taylor rule parameter $\delta$ is 0.45. This implies an aggressive monetary stance: for every 1 percentage point increase in inflation, the Central Bank raises the MPR by approximately 2.3 percentage points (calculated as $1/\delta$ ).
Policy Impact: A 1 percentage point (100 basis points) increase in the MPR results in:
- A decrease in inflation of approximately 1.1%.
- A decrease in output of approximately 1.8%.
Transmission Lags: The study identifies significant delays in the transmission mechanism. Policy lags for inflation range between seven to thirteen months, while lags for output range between three to seventeen months.
Interest Rate Spreads: Descriptive statistics and graphical analysis reveal a wide and persistent spread between the average lending rate and the savings deposit rate. While the MPR correlates closely with interbank and treasury bill rates, the pass-through to retail lending rates is inefficient, favoring bank profitability but hindering investment and consumption.

Significance and Contributions
The paper contributes to the literature by providing a structural, model-based assessment of monetary policy transmission in Ghana, a context often characterized by data limitations and structural heterogeneity.

Validation of Aggressive Stance: The study confirms that the Bank of Ghana adopts an aggressive anti-inflationary stance, raising rates significantly in response to inflationary pressures, a finding that aligns with previous literature on restrictive monetary measures in the region.
Quantification of Transmission Delays: By explicitly modeling the time lags, the paper quantifies the substantial delay (up to 13 months for inflation) before policy rate adjustments fully impact price levels, offering a realistic timeline for policymakers.
Identification of Structural Frictions: The results highlight that while the Central Bank is responsive, the effectiveness of the MPR is dampened by structural issues, specifically the high interest rate spreads and the reluctance of commercial banks to lower lending rates when the MPR is cut. This weakens the interest rate channel and limits the policy's ability to stimulate growth.
Policy Implications: The paper argues that for the MPR to function effectively as a signaling tool, the Central Bank must address the disconnect between policy rates and retail rates. Recommendations include creating pathways for commercial banks to lower lending rates in sync with MPR cuts without disrupting competition and ensuring fair spreads between lending and deposit rates to foster financial inclusion and private sector participation.

The study concludes that while the MPR is a valid tool for signaling, its efficacy is currently constrained by structural rigidities and transmission delays, necessitating complementary measures to improve the financial intermediation process in Ghana.

Technical Summary: The Monetary Policy Rate and Inflation in Ghana

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