Page 1 of 14

Journal for Studies in Management and Planning

Available at http://edupediapublications.org/journals/index.php/JSMaP/

e-ISSN: 2395-0463

Volume 02 Issue 7

July 2016

Available online: http://edupediapublications.org/journals/index.php/JSMaP/ P a g e | 41

Impulse-Response function Analysis: An application to

macro-economy data of Ghana.

Kwame Antwi, MSc. Applied Statistics1 & Emmanuel Amoah, Mphil Statistics2

1 Department of Mathematics, Kwame Nkrumah University of Science and technology-Ghana

Email: kantwi35@yahoo.com

2 Department of Statistics, University of Ghana

Email: emmanuelamoah27@gmail.com

ABSTRACT

This paper attempts an empirical

investigation of the impact of foreign direct

investment (FDI) on Ghana GDP growth

using impulse response function(IRF)

analyses for annual time series data from

1980 to 2013; whether FDI improves or

worsens GDP growth has been at the centre

of literature debate over time with varying

empirical evidences for developed and

developing nation. The empirical results

indicate that there exist a long-run

stationary relationship between GDP

growth and its determinant- FDI, money

supply (M2) and trade balance (TB); as

employed in the study. On the IRF analyses,

when the impulse is GDP growth rate,

almost all response of foreign direct

investment is positive, the value is only

negative at year two; every response of

trade balance is all positive at each time

responsive period; the response of money

supply fluctuates. The paper concludes with

important implications for policy makers

because it provides evidence supporting that

fact that level of TB has a major impact on

GDP growth in Ghana.

KEYWORDS: Impulse Response Function

(IRF), GDP, FDI

INTRODUCTION

Like many developing countries, the

primary focus of policies in Ghana is to have

high and sustainable growth. However, to

achieve and maintain a high growth rate,

policy makers need to understand the

determinants of growth as well as how

policies affect growth. Since World War II,

the trend growth of real GDP has become a

key policy objective in almost all countries

(See Crafts 2000).

A wide range of studies have investigated

the factors underlying economic growth.

Using differing conceptual and

methodological viewpoints, these studies

have placed emphasis on a different set of

explanatory parameters and offered various

insights to the sources of economic growth

(Lichtenberg, 1992; Lensink & Morrissey,

2006). Investment is the most fundamental

determinant of economic growth (Artelaris

et al., 2007) identified in the literature. The

importance attached to investment has led to

an enormous amount of empirical studies

examining the relationship between

investment and economic growth (Artelaris

et al., 2007).

Economic policies and macroeconomic

conditions have also attracted much

Page 2 of 14

Journal for Studies in Management and Planning

Available at http://edupediapublications.org/journals/index.php/JSMaP/

e-ISSN: 2395-0463

Volume 02 Issue 7

July 2016

Available online: http://edupediapublications.org/journals/index.php/JSMaP/ P a g e | 42

attention as determinants of economic

performance. This is because they can set

the framework within which economic

growth takes place (Barro & Sala-i-Martin,

1995). Economic policies can influence

several aspects of an economy through

investment in human capital and

infrastructure, improvement of political and

legal institutions. In addition, a stable

macroeconomic environment may favour

growth through the reduction of uncertainty,

whereas macroeconomic instability may

have a negative impact on growth through

its effects on productivity and investment.

Several macroeconomic factors with impact

on growth identified in the literature include

inflation, fiscal policy, budget deficits and

tax burdens (Fischer, 1993).

Foreign Direct Investment (FDI) has

recently played a crucial role of

internationalizing economic activity and as a

primary source of technology transfer and

economic growth. The empirical literature

examining the impact of FDI on growth has

provided more-or-less consistent findings

affirming a significant positive link between

the two (Lensink & Morrissey, 2006).

The effect of foreign direct investment on

economic growth is dependent on the level

of technological advance of a host economy,

the economic stability, the state investment

policy and the degree of openness. FDI

inflows can affect capital formation because

they are a source of financing and capital

formation is one of the prime determinants

of economic growth. Inward FDI may

increase a host’s country productivity and

change its comparative advantage. If

productivity growth were export biased then

FDI would affect both growth and exports.

A host’s country institutional characteristics

such as its legal system, enforcement of

property rights, could influence

simultaneously the extent of FDI and

inflows and capital formation in that

country.

Βorensztein, et al. (1998) highlight the role

of FDI as an important vehicle of economic

growth only in the case that there is a

sufficient absorptive capability in the host

economy. This capability is dependent on

the achievement of a minimum threshold of

human capital.

To better understand the growth process,

this paper develops an empirical model

using a time series data from 1980-2013,

which attempts to explain some of the

necessary ingredients for sustained

economic growth in Ghana.

METHODOLOGY

Source of Data and Data Collection

Procedure

All series examined in this study; trade

balance, real exchange rate, real GDP and

money supply- are collected from Bank of

Ghana and WDI, World Bank. The data is

annual and spans the time period 1980 to

2013, which gives thirty four (34) data

points which is statistically large to be used

for the study.

Definitions and Measurements of

Variables

GDP

GDP refers to the value of all final goods

and services produced within a country or an

Page 3 of 14

Journal for Studies in Management and Planning

Available at http://edupediapublications.org/journals/index.php/JSMaP/

e-ISSN: 2395-0463

Volume 02 Issue 7

July 2016

Available online: http://edupediapublications.org/journals/index.php/JSMaP/ P a g e | 43

area in a period of time (a quarter or a year),

and is often considered the best standard of

measuring national economic conditions

(Mankiw & Taylor 2007).

Foreign Direct Investment (FDI)

FDI net flows are the value of inwards direct

investment made by non-resident investors

in the reporting economy.

Money Supply (M2)

Are the currency and coins in circulation

plus the demand deposits held by non- banking institutions, deposits and

certificates of deposits held by public and

private sectors.

Trade Balance (TB)

Trade balance is the difference in monetary

value between exports and im-ports. This

was measured in terms of the US dollars.

Unit Root Tests

Confirming the order of integration is a pre- requisite for almost all time series analysis.

In this study, we applied the Augmented

Dickey-Fuller (ADF), Phillips-Perron (PP)

and Kwaitkowski-Phillips-Schmidt-Shin

(KPSS) unit root tests to determine the order

of integration for each series. Since the ADF

test is low power in small sample Cheung &

Lai, (1995), we also applied the PP and

KPSS unit root tests to check the robustness

of the estimation results.

Impulse response function

Impulse response function (IRF) of a

dynamic system is its output when presented

with a brief input signal, called an impulse.

More generally, an impulse response refers

to the reaction of any dynamic system in

response to some external change.

A VAR was written in vector MA(∞) form

as yt= μ + εt + Ψ1εt−1+ Ψ2εt−2+⋯

[1].Thus, the matrix Ψs has the

interpretation ∂yt+s

∂ε′t

=Ψs

that is, the row I,

column j element of Ψs

identifies the

consequences of one unit increase in the jth

variable’s innovation at date t (εjt) for the

value of the ith variable at time t+s(yit+s

),

holding all other innovations at all dates

constant.

∂yit+s

∂ε′jt

as a function of s is called the impulse

response function. It describes the response

of ∂yit+s

to a one-time impulse in yjt with

all other variables dated t or earlier held

constant.

Co-integration Test

Cointegration means that despite the data

being non-stationary at levels in each

variable, a linear combination of two or

more time series can be sta-tionary and this

means that there exist a long-run equilibrium

relationship among them (Gujarati 2003).

The null hypothesis is that the series is not

cointegrated against the alternative

hypothesis that the series is cointegrated. If

the series is cointegrated, modeling of the

long-run relationship among variables is

necessary. In such a case, the VECM is

applied to reconcile the static long-run

equilibrium relationship of cointegration