Effects of inflation and inflation targeting policy on foreign direct investment inflows in Ghana

Abstract

Ghana, like other developing countries, relies on external financial assistance for budgetary support as well as capital projects. It is therefore anticipated that Foreign Direct Investment (FDI) will continue to play a critical role in bridging the financial gap and support government’s quest to provide public infrastructure and services for Ghanaians. This study sought to establish relationship among macroeconomic variables, specifically between inflation, FDI inflows and the policy of inflation targeting in Ghana. This study was modeled on the Accelerator theory of investment. The sample consisted of annual time series data spanning 26 years from 1990 – 2015. The study used Error Correction Mechanism to integrate long run and short run effect of inflation and other macroeconomic variables on FDI. The results indicated significant negative long run relationship between inflation and FDI in Ghana. Also, FDI is significantly error correcting at 43% annually while inflation targeting has both short and long run positive effect on FDI. However, the result from the DOLS estimation shows that inflation has no effect on FDI inflows. The policy implication of the study is that Ghana needs to implement inflation lowering policies in order to be able to attract FDI inflows. Also, strong GDP growth leads to larger market size, the government need to initiate policies to maintain the momentum in GDP growth necessary for Ghana to attract FDI. The study therefore concluded that Inflation Targeting should be continued and not truncated since it affects the inflow of FDI positively.