Analyzing the Structural Relationship between Money Supply, Inflation, and Economic Growth in Sierra Leone: A VAR Model Approach

Abstract

This study examines the structural relationship between money supply, infla-tion, and economic growth in Sierra Leone using the Vector Autoregressive (VAR) model from 1981 to 2022. The study employed the unit root tests, granger causality tests, impulse response analysis, and variance decomposition analysis to investigate the causal relationship between the key macroeconomic indicators used in the study. Through applying the ADF and PP tests, it is as-certained that the variables used in the model are stationary at the first differ-ence. Findings from the Granger causality tests revealed that there exists uni-directional causality from money supply to GDP Per Capita and no causality between inflation and GDP per capita. On the other hand, there exists a bidi-rectional causality between money supply and inflation. The Impulse response functions suggest that GDP Per Capita responds to shock in the Money Supply, and the response seems to be significantly negative, indicating an adverse long-term effect. Variance decomposition analysis further underscores the pivotal role of money supply in influencing GDP per capita, while inflation’s impact remains relatively weak. The study’s findings emphasize the critical importance of money supply management in promoting economic growth and maintaining financial stability.