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Exchange Rate Behavior in Ghana: Is there a Misalignment?

Lordina Amoah and Meshach Aziakpono ()

Journal of Developing Areas, 2017, vol. 51, issue 4, 261-276

Abstract: Exchange rate misalignment results in resource misallocation and could hamper overall economic growth. Persistent undervaluation leads to high levels of inflation which in turn creates macroeconomic instability while overvaluation leads to trade imbalances with consequential balance of payment problems. Since the redenomination exercise in 2007, the Ghana cedi has been consistently depreciating. This has sparked a lot debate in the public media and among academics concerning possible misalignment of the cedi. This paper investigates the behaviour of the Ghanaian cedi using the behavioral equilibrium exchange rate approach for the period 1980Q1 to 2013Q4. The Johansen cointegration and error correction modelling framework is employed in estimating a model of the real effective exchange rate. Unlike previous studies, this paper employs the real effective exchange rate computed by authors due to certain adjustments made in the International Monetary Fund, International Financial Statistics series. The results point to significant misalignment of the exchange rate with undervaluation before the redenomination in 2007 and overvaluation afterwards. The empirical finding of this study has implications for policy direction. Monetary authorities should seek to strike a balance between the two extremes of overvaluation and undervaluation. This may be achieved by pursuing a pure floating exchange rate system where the exchange rate is allowed to follow the path dictated purely by market forces, without any intervention by the Central Bank. Alternatively, a properly managed float system of exchange rates may be pursued. Hence, given the current state of overvaluation, a once-off devaluation of a minimum of 20% could be considered to bring the exchange rate close to its equilibrium. Subsequently, monetary authorities should closely monitor deviations from the equilibrium path and engage in timely interventions. In addition, policy should be directed at strengthening the economy’s fundamentals with particular attention to the export and productive sectors by creating a conducive business environment that promotes private investment and supports the production of high quality goods of international standard both for the external and domestic market.

Keywords: Real effective exchange rate; Misalignment; Behavioral equilibrium exchange rate; Johansen cointegration procedure; Ghana (search for similar items in EconPapers)
JEL-codes: F31 C22 F41 (search for similar items in EconPapers)
Date: 2017
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Handle: RePEc:jda:journl:vol.51:year:2017:issue4:pp:261-276