Assessing the Impact of Domestic Credit on Economic Performance in Ghana: An Instrumental Variable Model

Domestic credit growth has remained a central policy concern in Africa, where financial deepening is often accompanied by structural inefficiencies that limit its contribution to sustainable development. In Ghana, despite persistent credit expansion, questions remain as to whether this growth fuels productive investment or merely supports consumption and fiscal imbalances. This study examines the impact of domestic credit on economic performance in Ghana, engaging the debate on whether credit expansion serves as an enabler of growth or a constraint. The precise effect of credit on real GDP per capita remains ambiguous, partly due to endogeneity and reverse causality. Using a Two-Stage Least Squares (2SLS) instrumental variable approach over the 1984-2023 period, the analysis employs broad money supply as an instrument for domestic credit while controlling for gross capital formation, government expenditure, inflation, and trade openness. The findings reveal a significant bidirectional relationship between credit and growth, indicating that credit expansion alone does not guarantee sustained performance without addressing inefficiencies in allocation. The results further show that government expenditure and trade openness enhance growth, while inflation has a negative effect. This study concludes that financial sector reforms, improved credit targeting, prudent fiscal management, and strengthened trade competitiveness are critical for maximising the developmental impact of domestic credit in Ghana.