The effect of crude oil price shocks on macroeconomic stability in Ghana

• Published date: 01 September 2020
• DOI: http://doi.org/10.1111/opec.12182
• Date: 01 September 2020

The effect of crude oil price shocks on

macroeconomic stability in Ghana

John Bosco Dramani and Prince Boakye Frimpong

Department of Economics, KNUST, Kumasi, Ghana. Email:

boscodramani@knust.edu.gh/boscodramani@gmail.com

Abstract

The paper studies the effects of underlying shocks of crude oil price movements on the stability of

macroeconomic aggregates in Ghana. We develop a structural vector autoregressive to disentangle

the sources that have driven shocks in crude oil market and estimate the effects of the identified

shocks on macroeconomic aggregates and on three bilateral exchange rates in Ghana. In addition,

we investigate the extent of transmission of the identified shocks on food and non-food price

levels. The findings show that shocks by oil supply and demand-specific have a significant effect

on real GDP. Further, the identified shocks have a weighty effect on the Ghana/Euro bilateral

exchange rate. The findings also suggest that all the identified structural shocks have significant

effects on food and non-food inflation. This implies that oil market shocks are detrimental to food

and non-food inflation in Ghana.

1. Introduction

Since the 1970s, economists have been interested in the empirical evidence that shows

that macroeconomic performance of a country may have some relationships with oil

price shocks. This was motivated by the presence of an increasing reliance on oil

imports, unparalleled interruptions in the international oil market and weak macroeco-

nomic stability in many countries of the world. It was therefore obvious for economic

agents to suspect oil price shocks may be responsible for fluctuations in macroeconomic

aggregates. As a result, a staggering amount of empirical studies supported by theory has

been undertaken to study the effect of oil price shocks on macroeconomic aggregates.

These studies indicate that although the ultimate impact of oil price shocks on

macroeconomic aggregates is of similar magnitudes, the channels of transmission are

completely different among countries due to the structure of their economies, energy

intensity and as to whether they are importing or exporting countries.

In 2007, Ghana found huge deposits of crude oil, and by the close of the fourth

quarter of 2010, the country had become the much-anticipated oil and gas economy.

Projections of oil production from the Jubilee Fields

1

, as well as the exploration of other

©2020 Organization of the Petroleum Exporting Countries. Published by John Wiley & Sons Ltd, 9600 Garsington

Road, Oxford OX4 2DQ, UK and 350 Main Street, Malden, MA 02148, USA.

249

hydrocarbon sites, indicate that Ghana is likely to become a net exporter of crude oil in

the future. The total volume of crude oil production in 2011 was about 24 million

barrels, and this rose to a total of over 28 million barrels in the fourth quarter of 2016

(Ministry of Finance, 2017). The cumulative production of crude oil in Ghana from 2011

to 2016 amounted to over 198 million barrels. The associated revenue from the sale of

oil rose from about $181 million in 2011 to over $2 billion in the second quarter of 2017

(Ministry of Finance, 2017).

The direction and extent to which crude oil revenue will influence macroeconomic

aggregates are contingent on the price, the volumes of exports and the management of

the revenue. Before the export of crude oil in commercial quantities in Ghana, the price

had reached a record high of $147 per barrel by the middle of 2008. Although

projections indicate that the international price of oil will moderate in recent times, they

are anticipated to remain more than 75 per cent higher than in 1999. The increases in oil

prices generate considerable amount of wealth to the exporting countries such as Ghana.

Alternatively, increases in the price of oil possess the potential of causing recession,

inflation, appreciation of the domestic currency, low productive activity and low growth

of importing countries.

The high oil prices experienced between 1999 and 2008 were driven by many factors

including the staggering economic growth of China and India as well as disruption of

supply from the producing countries. However, the reaction of macroeconomic

aggregates to oil price hikes will differ based on the sources of shocks. Unfavourable

oil supply shocks due to production disruption usually cause low oil production, high

production cost fuelling inflation and dampening economic activity. To this end,

monetary authorities of oil-importing countries need to make a trade-off between

inflation stabilisation and output. Similarly, oil price hikes could also be attributed to

high demand for oil, brought by high economic growth or precautionary demand. Oil-

exporting countries will accommodate the increase in demand by producing more oil and

increasing investment in exploration of new hydrocarbon sites. On the other hand, the

monetary authorities of oil-importing countries will experience rising inflation but the

change in output will be different (Peersman and Van Robays, 2009). This is possible

when part of the wealth generated from the export of oil is obtained through increased

trade, which reduces the adverse impact on output. On this basis, macroeconomic

aggregates of oil-importing countries will not be affected the same way since their

Central Banks will not necessarily have to make a balance between price stabilisation

and output.

There is evidence of scanty works on the macroeconomic effect of oil price and the

precise channels of transmission which makes it difficult to decide on suitable monetary

policy reaction in Ghana. A research of this nature is very important since Ghana is both

an exporter and importer of oil. The country exports the crude but imports the refined oil

OPEC Energy Review September 2020 ©2020 Organization of the Petroleum Exporting Countries

250 John Bosco Dramani