Journal of Finance & Economics Volume 2, Issue 3 (2014), 16-30 ISSN 2291-4951 E-ISSN 2291-496X Published by Science and Education Centre of North America ~ 16 ~ Separating Monetary and Structural Causes of Inflation Simon K. Harvey 1* and Matthew J. Cushing 2 1 Department of Finance, University of Ghana Business School, University of Ghana-Legon, Ghana 2 Department of Economics, College of Business Administration, University of Nebraska-Lincoln, USA *Correspondence: Simon K. Harvey, University of Ghana, Department of Finance, Box LG 78, Legon, Ghana. Email: sharvey@ug.edu.gh DOI: 10.12735/jfe.v2i3p16 URL: http://dx.doi.org/10.12735/jfe.v2i3p16 Abstract The paper employs a structural vector autoregression (SVAR) to model inflation so as to identify the relative importance of shocks to real output growth, monetary growth and exchange rate depreciation in inflation dynamics in developing countries using data from Ghana. The results show that either monetary growth or structural factors alone do not explain the inflation experience and that the structural factors dominate monetary growth in the inflation dynamics. There is a fairly strong feedback between inflation and exchange rate depreciation both of which have weak relationship with monetary growth. These suggest that policies that boost domestic supply and therefore reduce import demand will be more potent than direct monetary management to curb inflation in Ghana. JEL Classifications: E52, E31 Keywords: monetary, structural, inflation 1. Introduction and Theoretical Framework There are two schools of thought on what explains inflation; monetarist school and structuralist school. The monetarist school argues that money is all that matters in explaining inflation. This forms the basis of the monetarist statement that “inflation is always and everywhere a monetary phenomenon”. The structuralist school, on the other hand, argues that structural and institutional factors play a more prominent role in inflation dynamics. The structuralists’ argue that inelastic food supply, infrastructural inadequacies that pose problems for distribution of output, lack of financial resources and low export receipts leading to foreign exchange shortages in developing countries put pressure on domestic prices (London, 1989). “The nominal exchange rate pass- through to domestic price inflation depends on how the changes in the exchange rates are passed through to import prices and therefore to domestic consumer prices” (Mishkin, 2008). It is also argued that the lack of financial resources coupled with a limited tax base cause these less developed countries to resort to deficit financing through the central banks, that lead to inflationary pressures. This study uses a structural vector autoregression (SVAR) to model inflation so as to identify the relative importance of monetary and structural factors in explaining inflation in developing countries by using data from Ghana. The objectives of this paper are three fold; first, the paper identifies the relative importance of output supply shocks, monetary growth shocks and exchange rate depreciation shocks in inflation dynamics by analyzing the variance decomposition of the