The Impact of Inflation Rate and Interest Rate on Financial Sector Development in Ghana; Time Series Approach

Abstract

The development of the financial sector of an economy has been empirically established as an important component of economic growth. The study in using bank private credit to the private sector as a proxy of financial sector development seeks to use causal research design to examine the impact of inflation rate and interest rate on financial sector development in Ghana from 1980-2015. The study also employed time series data and secondary data obtained from the World Bank development indicators and Dynamic OLS regression technique in analyzing the data. Theories existing are divided on the relationship existing between inflation-finance and interest rate-finance. Whilst certain theories are with the opinion of a negative relationship between inflation and financial sector development, others say otherwise. However, generally most theories assert that inflation has a negative impact on FSD. The contrasting opinions are not different with interest rate. Three theories were reviewed under this study; they are the finance-inflation theory, McKinnon-Shaw hypothesis and credit rationing theory. The study established that inflation has a negative and statistically insignificant relationship with financial sector development. Interest rate on the other hand also yielded a negative statistically significant relationship with financial sector development. As part of policy recommendation, this study maintains that, efforts should be made by the government and other monetary institutions to keep inflation rates low and stable. Finally, interest rates should also be low and stable to induce deposit at the banks.