Dynamic modelling of fiscal and exchange rates policy effects in a developing country

Abstract

A non‐structural model is used to analyze the dynamic effects of fiscal and exchange rate policies on Ghana's economy. In particular, the paper sheds light on how these two key structural adjustment policy variables affect the short‐run and long‐run dynamics of inflation, output and exports. The general conclusion is that exchange rate changes have a moderate dynamic effect on inflation, output and exports. In contrast, government expenditures are less effective in influencing any of the above macroeconomic variables, either in the short‐run or in the long‐run. The impulse response functions derived from the VAR suggest that the impact of devaluation is strongly felt in either the third or the fourth year. The variance decompositions indicate that exchange rate changes account for about 30 percent, 7 percent and 27 percent in the variation of ouput, inflation and exports, respectively, in the ninth year. However, the percentage of the variation in the above variables owing to changes in government expenditures is very small. The implication of these results is that the structural adjustment policies in relation to changes in exchange rate and government expenditures may not be very effective as previously envisaged.