Optimal Deficit Financing in a Constrained Fiscal Space in Ghana

Ghana's public debt has been on the rise in recent years, raising questions of fiscal sustainability. At the same time prices of Ghana's main commodities such as crude oil, gold and cocoa have not fared well in world markets. Coupled with an underdeveloped financial system and weak domestic revenue mobilization capacity, the higher public debt levels pose a significant challenge to macroeconomic stability, and long‐run economic growth. This study contributes to a better understanding of the growth effects of high fiscal deficit in Ghana. We employ annual data spanning 1967–2013 and a sample splitting approach to examine the threshold level of Ghana's fiscal deficit and its impact on the country's economic growth. Our finding reveals an optimal fiscal deficit of 7.6 per cent of GDP. We find that the impact on economic growth of fiscal deficit is negative regardless of the sample splitting. However, our evidence shows that this effect is only statistically significant above the threshold. Although, the impact of fiscal deficit on growth is less clear and debatable, we document that fiscal deficit significantly hurts growth when the level exceeds the threshold. We discuss key implications for policy.