Cedi Depreciation and Petroleum Price Shocks: Economic Interlinkages and Macroeconomic Implications

The continuous depreciation of Ghanaian Cedi, together with the increasing price of petroleum is creating a vicious cycle, which is dangerous to the macro-economic stability. This study is an empirical investigation of the dynamic interdependence between nominal exchange rates, domestic petrol prices, inflation, world oil prices, interest-rate differentials, fiscal deficit and terms of trade using a panel of 120 monthly observations, 2014M01-2023M12. Using a six-variable Vector Error-Correction Model (VECM), we first establish that two long-run relationships between variables are cointegrating through the Johansen procedure. The estimated long run coefficients indicate that the effect of the world oil prices and domestic inflation is depreciating the Cedi by statistically significant values, but exchange rate has an almost perfect pass through to domestic petrol prices and the estimated elasticity is 0.89. Variance-decomposition analysis proves that petroleum sector shocks can explain 42 percent of exchange rate long-term variance within a 24-months’ time frame. The size of the error-correction term signifies that 18.7 individual of any disequilibrium is reinstated monthly. All these findings are indicative of the structural dependence that Ghana has on imported fuel and the need to engage in concerted short-term stabilization measures and long-term diversification measures. JEL classification codes: F31, Q43, F41, E31, C32, O11