TITLE:
Analysis of the Goods Market and Money Market Equilibrium in a Developing Country
AUTHORS:
Insah Baba, Ofori-Boateng Kenneth
KEYWORDS:
IS-LM; Simultaneous Equation; Real Interest Rate; Real Money Balances
JOURNAL NAME:
Modern Economy,
Vol.5 No.1,
January
23,
2014
ABSTRACT: The relationship between
interest rate, real money balances and real output may be explored in an IS-LM
framework. The objective of this study is to explore the connection between
real interest rate, GDP and real money balances. It also empirically tests for
the nature and existence of the IS-LM framework in Ghana. Employing a simple
IS-LM framework, the Two Stage Least Squares (TSLS) estimation technique is
used for the analysis. The main contribution of this paper is the use of a
simultaneous equation framework to investigate interest rate and GDP growth
determinants. This is imperative since interest rate is both an explanatory and
an explained variable. The results indicated that real money balances exerted a
negative but significant influence on real interest rate. The growth rate of
GDP had a dominant influence on real interest rate. On the other hand,
investment expenditure exerted significant and positive influence on GDP
growth. Meanwhile, as informed by economic theory, interest rate changes had a negative
and significant influence on GDP growth. The study recommends
the role of monetary policy and economic growth in exchange rate management.
Also, policy focus should be on interest rate since interest rate is seen in
this study as a stronger driver of economic growth in Ghana compared with
investment expenditure.