Testing the Link Between Devaluation and Inflation: Time Series Evidence from Ghana

Policy makers in Africa often argue that devaluation leads to inflation. This is undesirable in itself and also because the inflation mitigates any impact that the nominal devaluation has on the real exchange rate, which is what one hopes to change in the face of balance of payments problems. This paper argues that, under the extensive trade and exchange restrictions that are common in Africa, devaluation of the official exchange rate should have little impact on domestic prices. It tests that hypothesis with time series techniques due to Box and Tsiao (1975) using data from Ghana for the period 1974-86 when exchange controls were severe. The paper's main conclusion is that devaluations in Ghana have had a small but statistically significant impact on the domestic CPI: for a 100 per cent increase in the exchange rate, prices rise by 5 to 10 per cent.