REAL ECONOMIC GROWTH RATE IN GHANA: THE IMPACT OF INTEREST RATE, INFLATION RATE AND GDP

REAL ECONOMIC GROWTH RATE IN GHANA: THE IMPACT OF INTEREST RATE, INFLATION RATE AND GDP Alice C. Mensah 1, Ebenezer Okyere 2 1. Accra Polytechnic, Mathematics and Statistics Department, Accra 2. Bank of Ghana, Research Department, Accra. Abstract The main objective of this study is to investigate the effect of interest rate, inflation rate, and GDP on real economic growth in Ghana over the period 1980-2012. Unit root test (Augmented Dickey-Fuller test) has been exploited to check the integration order of the variables. A co integration analysis with four variables (economic growth, interest rate, GDP, and inflation level) is employed as well as the use of Johansen test.. Findings indicated, Inflation had a mean value of 29.81 with its maximum value being 142.40 during the period under review. Interest rate, real GDP and real Growth had mean values of 23.52, 13,290.06 and 4.64 respectively. The highest growth rate was 13.64 and that of real GDP was 29,718.00 within the period. Also both trace test and max eigenvalue static showed that the four equations have significant existent at 5%. It means that all variables have long term equilibrium relationship. Interest rate has a significant influence (negative), on real growth rate. Real GDP is the most significant variable affecting real growth rate positively. Study adopted the same four variables to discuss Granger Causality relationship. The granger causality revealed bilateral relations between GDP and real growth rate and a significant relation between i nterest rate and real GDP was also seen. Inflation rate, although found to have a positive relation on real economic growth, was insignificant. However a bilateral relation exits between them. In conclusion, real GDP and Interest Rate have a significant in fluence on the economic growth of Ghana. Keywords: Inflation, Economic Growth, Interest Rate, GDP 1. INTRODUCTION Economic growth is defined as an increase in the number of goods and services produced in an economy in a given time period, usually a year [1]. Economic growth in any country reflects its capacity to production of goods and services. It is a long-run process that occurs as an economy s potential output increases. Thus, increase in potential constitutes economic growth. The three key points about economic growth are: growth is a process, an unfolding series of events; growth is defined in terms of the economy s ability to produce goods and services as indicated by its level of potential output and finally growth suggests that the economy s ability to produce goods and services is rising. The simplest definition of economic growth can be stated as the increase in the Gross Domestic Product (GDP) of a country. GDP of a country equals the value of final output produced within the borders of that country. It is the measure most often used to assess the economic well-being of a country and it is also used to compare living standards in different countries. To use GDP as an indicator of overall economic performance, it must be converted from nominal to real GDP, since nominal values can rise or fall simply as a result of changes in the price level. Nominal GDP is usually adjusted for inflation factor to reflec t real GDP. Inflation is measured as the annual rate of increase in the average level of prices. Inflation always produces the following effects on the economy: it reduces the value of money and reduces the value future monetary obligations. It can create uncertainty about the future. Interest rate is one of the macroeconomic growth factors, whos e up and down volatility is closely related with inflation rates. An interest rate is the payment made for the use of money, expressed as a percentage of the amount borrowed. It s high or low rate impact the economic boom (high GDP) and extends to influence economic growth rate. According to [2], large increase in the rate of interest could through other variables have a negative effect on the GDP. 1.1 Research Problem Measuring real economic growth of a country aims to assess whether growth can cope with the growing demands of the society including the population and prosperity growth rates; and how to maintain and confine the depletion rate of its national natural resources. This study is a contribution to the existing literature on real growth applied to Ghana s economy; it will examine the effect of interest rate, inflation, and Real GDP on the real growth rate of Ghana s economy. Study is concerned to analyze: - The relationship between Interest rate and inflation rate, - The relationship between GDP and economic growth rate. - The Effect of Interest rate, Inflation rate, and R. GDP, on Real Economic Growth Rate. 206 P a g e e d i t o r @ g p c p u b l i s h i n g. c o m

1.2 Research Questions 1. Is there a significant effect of inflation on real economic growth rate? 2. Is there a significant effect of interest rate on real economic growth rate? 3. Is there a significant effect of Real GDP on real economic growth rate? 2. LITERATURE REVIEW There were many researches and investigations to identify and analyse the relationship between inflation and economic growth which were carried out by [3,4], and they all identified the relationship between two variables. They all tend to conclude that a consistent economic growth can be achieved with low consistent inflation rates; however, higher inflation rates distort the economic growth consistency of any country. [5], indicates that one of the determinants of macroeconomic stability is inflation, and long term economic growth requires macroeconomic stability which will be achieved through low inflation along with sustainable budget deficits, realistic exchange rates and appropriate real interest rates. He points out that the stability of inflation rates has an enormous impact on the economic growth of the country. One of the consequences of inflation stated by [6], is that it leads to uncertainty about the future potential investment projects and ultimately results in lower levels of investments which in turn results in lower levels of economic growth. [7] claim that inflation may also reduce country s international competitiveness, by making its exports relatively mor e expensive which impacts on the balance of payments. Moreover, it also can impact the country s tax system to distort borrowing and lending decisions. In particular, according to other researchers, medium and high inflation adversely impacts on efficient distribution of resources [8]. However, many more, including [9] mentioned that low levels of inflation promote economic growth. [10] found evidence of negative impact of increase in real interest rate on corporate investment in the macroeconomic data (with the impact ranging between 51 to 34 bps in different estimates for 100 bps change in real interest rate), while for the firm level data profitability, liquidity and leverage were highlighted as the key determinants of corporate investment in India.[11], estimates highlighted that compared with nominal interest rate the real interest rate explains better fluctuations in economy wide investment activities, and also suggested that one fourth of the explained slowdown in investment activities could be attributed to high real interest rates. In China, according to estimates provided by [12], 100 bps increase in real rate lowers corporate investment by 0.5 per cent of GDP. Since real rates are much lower than the marginal productivity of capital, which in turn is a source of investment driven macro-imbalance, they suggested higher real rates closer to MPC to rebalance the economy, with lower investment and more consumption. [13] Aimed to check whether inflation and economic growth have a structural break point e ffect. He found that there is a positive structural effect at inflation rate of 2%, while at higher rates effect turned to be negative. A paper by [14] explored the connection between interest rates in major industrial countries and annual real output grow th in other countries. The results show that high foreign interest rates have a contractionary effect on annual real GDP growth in the domestic economy, but that this effect is centered on countries with fixed exchange rates. The paper then examines the po tential channels through which major-country interest rates affect other economies. The effect of foreign interest rates on domestic interest rates is the most likely channel when compared with other possibilities, such as a trade effect. [15], examined possibility of threshold effect of inflation on economic growth in Azerbaijani economy over the period of 2000-2009. Estimated threshold model indicated that there is a non-linear relationship between economic growth and inflation in the Azerbaijani economy and threshold level of inflation for GDP growth is 13 percent. Below threshold level inflation has statistically significant positive effect on GDP growth, but this positive relationship becomes negative one when inflation exceeds 13 percent. [16], examined the implications of financial reform and interest rate behavior on the economic growth in Nigeria. Study results revealed that financial reform and interest rates have significant impact on economic growth in Nigeria; also, results implied that the interest rate behavior is important for economic growth. Test Hypotheses Ho-1: There is no significant effect of interest rate on economic growth. Ho-2: There is no significant effect of inflation on economic growth. Ho-3: There is no significant effect of GDP on economic growth. 3. METHODOLOGY Data was collected from Bank of Ghana: Nominal Interest rates, Inflation rates (CPI (consumer price index)) and GDP rates for the period 1980-2012. 207 P a g e e d i t o r @ g p c p u b l i s h i n g. c o m

4. TEST RESULTS AND ANALYSIS Table-1. The Descriptive Statistics of Variables INFL INT_RATE REAL_GDP RECO_GTH Mean 29.81 23.52 13290.06 4.64 Median 19.50 21.05 11552.35 4.88 Maximum 142.40 47.88 29718.00 13.64 Minimum 6.00 9.64 6203.75-5.85 Std. Dev. 29.66 11.20 6360.26 3.59 Skewness 2.37 0.70 0.98-0.96 Kurtosis 8.39 2.63 3.11 5.79 Jarque-Bera 70.87 2.87 5.33 15.30 Probability 0.00 0.24 0.07 0.00 Sum 983.57 776.14 438572.00 148.47 Sum Sq. Dev. 28154.15 4016.76 1.29E+09 399.59 Table 1 shows four variables descriptive statistics. Inflation had a mean value of 29.81 with its maximum value being 142.40 during the period under review. Interest rate, real GDP and real Growth had mean values of 23.52, 13,290.06 and 4.64 respectively. The highest growth rate was 13.64 and that of real GDP was 29,718.00 within the period. It finds growth rate and inflation rate to be non-normally distributed. Real GDP and interest rate are normally distributed because J-B ratio is not significant. According to Kurtosis all variables appear leptokurtic phenomena except interest rate. Unit Root Test Based on Augmented Dickey-Fuller test and Lag Length Based on Schwartz Bayesian Information Criterion, indicates that all variables do not reject unit root null hypothesis. This means that variables in the level stage are of non-stationary existence. First difference I (1) in the Unit root test showed that all of variables achieved 5% significant level. The lag length for growth rate is 1, Log GDP 1, inflation 1, interest rate 0,see Appendix A. Table 2: Unrestricted Co integration Rank Test (Trace) Hypothesized Trace 0.05 No. of CE(s) Eigen value Statistic Critical Value * None * 0.945152 137.1023 47.85613 0.0000 At most 1 * 0.761801 58.71634 29.79707 0.0000 At most 2 * 0.355946 19.98087 15.49471 0.0098 At most 3 * 0.259225 8.101593 3.841466 0.0044 Denotes rejection of the hypothesis at the 0.05 level Table-2 shows cointegration test which is conducted to examine if variables have long term equilibrium relationship. This study adopted Johansen test, from the findings, it has been realized that no matter which is traced, Eigen value static showed four equations have significant existent at 5%. This means tha t all variables have long term equilibrium relationship. 208 P a g e e d i t o r @ g p c p u b l i s h i n g. c o m

Direction of causality Null Hypothesis: Table 3: Pair wise Granger Causality Tests Number of Lags F value Decision INT_RATE does not Granger Cause INFL 2 0.43 Do not reject INFL does not Granger Cause INT_RATE 2 0.19 Do not reject INT_RATE does not Granger Cause INFL 3 0.27 Do not reject INFL does not Granger Cause INT_RATE 3 0.25 Do not reject INT_RATE does not Granger Cause INFL 5 0.53 Do not reject INFL does not Granger Cause INT_RATE 5 0.19 Do not reject LOGGDP does not Granger Cause INFL 2 11.99 Reject INFL does not Granger Cause LOGGDP 2 7.16 Reject LOGGDP does not Granger Cause INFL 3 1.60 Do not reject INFL does not Granger Cause LOGGDP 3 1.76 Do not reject LOGGDP does not Granger Cause INFL 5 0.63 Do not reject INFL does not Granger Cause LOGGDP 5 1.71 Do not reject RECO_GTH does not Granger Cause INFL 2 11.04 Reject INFL does not Granger Cause RECO_GTH 2 6.54 Reject LOGGDP does not Granger Cause INT_RATE 3 0.37 Do not reject INT_RATE does not Granger Cause LOGGDP 3 4.02 Reject RECO_GTH does not Granger Cause INT_RATE 3 0.38 Do not reject INT_RATE does not Granger Cause RECO_GTH 3 3.89 Reject RECO_GTH does not Granger Cause LOGGDP 3 4.50 Reject LOGGDP does not Granger Cause RECO_GTH 3 4.40 Reject Table 3 above showed the study adopting Pair wise Granger Causality test to examine the causal relations among four variables which are real growth rate, GDP, inflation and interest rate. Findings indicated that at lag 2, there was a bilateral granger cause between log GDP and inflation, but the causality was more significant for log GDP granger cause inflation. Similarly, bilateral granger cause between real growth rate and inflation. At lag3, three relationships were found to be significant; interest rate granger cause log GDP, interest rate granger cause real growth rate and a bilateral granger cause between real growth rate and log GDP. On the other hand all other varia bles were independent to each other; inflation with GDP, real growth rate with GDP, and interest rate with inflation rate, at lag 5. Table 4: The regression of Real growth rate (G) with log GDP, Interest Rate and Inflation Variable Coefficient Std. Error Prob. C 0.145914 0.064774 2.252685 0.0323 LOGGDP 103.0134 0.694819 148.2594 0.0000 INFL 0.000763 0.000862 0.885001 0.3837 INT_RATE -0.005837 0.001665-3.506540 0.0015 The regression analysis showed that, log GDP and interest rate had influence power on real growth rate. Inflation on the other hand is seen to have no influence on real growth rate per the study. 209 P a g e e d i t o r @ g p c p u b l i s h i n g. c o m

Discussions The main purpose of the work was to study the effect of real GDP, interest rate, and inflation on real economic growth in Ghana.. Study adopted a set of econometric tools such as: Unit root, Cointegration test and Granger Causality. In order to obtain accurate results, researchers had to analyze the relationship between econometric factors which are: interest rate, inflation rate, GDP, and real growth rate. Descriptively, Inflation had a mean value of 29.81 with its maximum value being 142.40 during the period under review. Interest rate, real GDP and real Growth had mean values of 23.52, 13,290.06 and 4.64 respectively. The highest growth rate was 13.64 and that of real GDP was 29,718.00 within the period. It finds growth rate and inflation rate to be non-normally distributed. Real GDP and interest rate are normally distributed The study adopted ADF unit root to test the results that all of variables were belonging to I (1) structure and lag length in interest rate was 0, inflation rate was 1, GDP was 1, and real growth rate was 1. The findings indicated that all the variables in this test had significant existence in co integrated vector. This means that all the variables had long term equilibrium existence. From Granger Causality examination, it was revealed that, Interest rate has a significant influence on real growth rate. The regression analysis also indicates significantly negative relationship (-0.005837) between interest rate and real growth rate. Thus, increasing interest rate by 100 points lowers real growth by 0.5 percent. This is consiste nt with studies done by [10, 12, 14 and 16]. Real GDP is the most significant variable affecting real growth rate (103.01) based on the regression analysis. The granger causality revealed a bilateral relations between GDP and real growth rate. Inflation rate, although found to have a positive relation on real economic growth, was insignificant. However a bilateral relation exits between them. This was found to be inconsistent with [3, 4 and 9]. The study also revealed a significant relation between interest rate and real GDP which is consistent to studies done by [14, 17]. A bilateral granger relation between inflation and GDP was also found, [15]. Furthermore, interest rate and inflation rate were seen to be independent, or expected real interest rates are invariant to the expected inflation rates, [17]. Conclusion The study, investigated the effect of interest rate, inflation, and GDP on Ghana s economic growth over the period of 1980-2012. Interest rate has a significant influence (negative), on real growth rate. Real GDP is the most significant variable affecting real growth rate positively. The granger causality revealed bilateral relations between GDP and real growth rate and a significant relation between interest rate and real GDP was also seen. Inflation rate, although found to have a positive relation on real economic growth, was insignificant. However a bilateral relation exits between them. In conclusion, real GDP and Interest Rate have a significant influence on the economic growth of Ghana. REFERENCES [1] Sabillion, C. (2007). On the causes of economic growth: the lessons of history. New York: Algora Publishing [2] Piana, V. 2001 Economics Web Institute. UTL: www.economicwebinstitute.org. [3] Barro,R. 1996, Determinants of economic growth, National Bureau of Economic research, NBER, Vol. No. 5698 [4] Gokal and Hanif, 2004, Relationship between inflation and economic growth, Reserve Bank of Fiji press, Vol. No. 2004/04 [5] Malik,(2005) Inflation and Economic growth Available: <http://www.dawn.com/2005/05/16/ebr11.htm> retrieved on: 25.05.2010 [6] Sheffrin, 2003, Macroeconomics, Principles and Tools, Third edition, Prentice Hall,London, p. 321 [7] Atkinson and Milward, 1998, Applied Economics, Macmillan Business,London, p.369 [8] Fisher, I., 1930. The theory of interest book., New York: Macmillan. Asian Economic and Financial Review, 2013, 3(3):341-354 354 [9] Lucas, R. 1973 Some International evidence on Output-Inflation Tradeoffs. American Economic Review, v.63, [10].Tokuoka, Kiichi (2012), Does the Business Environment Affect Corporate Investment in India?, IMF Working Paper, WP/12/70. [11] IMF (2013), India 2013 Article IV Consultation, IMF Country Report No. 13/37, February 2013. [12] Geng, Nan and N Diaye Papa (2012). Determinants of corporate investment in China: Evidence from cross -country firm level data, IMF Working Paper No. WP/ 12/80, International Monetary Fund. [13] Sweidan, O.D., 2004. Does inflation harm economic growth in Jordan, a economic analysis for the period 1990-2000. International Journal of Applied Econometrics and Quantitative Studies, 1(2): 41-66. [14] Giovanni, J. and J. Shambaugh, 2007. The impact of foreign interest rate on the economy. The Role of Exchange Regime. [15] Hasanov, F., 2010. Relationship between inflation and economic growth in Azerbaijani economy: Is there any threshold effect? Asian Journal of Business and Management Sciences 1(1): 01-11. [16] Obamuyi, T.M. and S. Olorunfemi, 2011. Financial reforms: Interest rate behavior and economic growth in nigeria. Journal of Applied Finance & Banking, 1.1(4): 39-55. [17] Mundell, R., 1963. Inflation and real interest. Journal of Political Economy 71: 280-283. 210 P a g e e d i t o r @ g p c p u b l i s h i n g. c o m

Appendix A Null Hypothesis: INFL has a unit root Augmented Dickey-Fuller test statistic -3.823662 0.0067 Test critical values: 1% level -3.661661 5% level -2.960411 10% level -2.619160 Null Hypothesis: D(INT_RATE) has a unit root Lag Length: 0 (Automatic - based on SIC, maxlag=0) Augmented Dickey-Fuller test statistic -5.539685 0.0001 Test critical values: 1% level -3.661661 5% level -2.960411 10% level -2.619160 Null Hypothesis: D(LOGGDP) has a unit root Augmented Dickey-Fuller test statistic -5.781256 0.0000 Test critical values: 1% level -3.679322 5% level -2.967767 10% level -2.622989 Null Hypothesis: D(LOGGDP) has a unit root 211 P a g e e d i t o r @ g p c p u b l i s h i n g. c o m

Augmented Dickey-Fuller test statistic -5.781256 0.0000 Test critical values: 1% level -3.679322 5% level -2.967767 10% level -2.622989 Null Hypothesis: D(RECO_GTH) has a unit root Augmented Dickey-Fuller test statistic -5.856323 0.0000 Test critical values: 1% level -3.679322 5% level -2.967767 10% level -2.622989 212 P a g e e d i t o r @ g p c p u b l i s h i n g. c o m