Liquidity trap at positive interest rates: myth or reality in Ghana’s debt-laden economy

This study investigates how rising government debt has weakened the effectiveness of monetary policy in Ghana between January 2014 and April 2023. Using a Vector Error Correction Model, impulse response functions and threshold regression analysis, the results show that domestic debt reduces credit availability to the private sector by absorbing financial resources, while external debt undermines transmission through exchange-rate and external-sector pressures. Threshold estimates identify debt-to-GDP levels beyond which the monetary policy rate loses statistical significance, confirming regime-dependent liquidity-trap dynamics even at positive interest rates. The findings extend the liquidity-trap concept to an African emerging-market context, demonstrating that debt accumulation and banking-sector fragility can replicate trap-like conditions outside advanced economies. Policy implications are clear: the Bank of Ghana must strengthen macroprudential regulation to safeguard resilience, adopt enhanced communication and forward guidance to anchor expectations and deepen fiscal-monetary coordination to ease pressure on private-sector credit. By identifying critical debt thresholds, this study provides a framework for preserving monetary traction in debt-laden economies and offers a foundation for future research on informal financial dynamics and cross-country comparisons in Africa.

This study provides important evidence that rising public debt can substantially weaken the effectiveness of monetary policy in emerging economies such as Ghana. In identifying this debt thresholds beyond which monetary policy loses traction, the research demonstrates how excessive domestic and external debt can create liquidity-trap-like conditions even when interest rates remain positive. The findings contribute to the broader literature on monetary transmission by extending liquidity-trap dynamics beyond advanced economies to an African context. The study also offers practical guidance for policymakers by emphasizing the need for stronger fiscal discipline, improved fiscal-monetary coordination, enhanced macroprudential regulation, and credible policy communication to preserve financial stability and support private-sector credit growth. More broadly, the research provides a useful framework for debt management and monetary policy design in highly indebted developing economies.