Trade Openness-Inflation Nexus in Sierra Leone: Testing Romer Hypothesis using ARDL Approach

Abstract

This study is based on Romer’s proposition that there is an inverse relationship between inflation and trade openness as opposed to the narrative that argues otherwise. Therefore, the objective of this study is to examine Romer hypothesis for Sierra Leone. To achieve this objective, the study utilized the ARDL bounds testing approach to cointegration using data for the period 1980-2020. In addition, a battery of diagnostic tests were conducted to confirm the robustness of the model. The bounds test result confirm that there is long-run association between inflation and the dependent variables in this study. The associated equilibrium correction term was also significant, further confirming the existence of long-run relationship. The key findings of the study is that the Romer hypothesis holds for Sierra Leone in both the long-run and the short-run, as inflation tend to ease with increase trade openness. The control variables, exchange rate and gross domestic product were found to have a positive and significant impact on inflation in both the short-run and long-run, whereas domestic credit to the private sector impacts inflation positively in the long-run but have a disinflationary impact in the short-run. Finally, money supply and real interest rate were found to have no effects on inflation in both the short-run and long-run. At the policy level, these results show that encouraging more trade and imports that embody technology or intermediate inputs is essential in taming inflation in both the short-run and in the long–run. This outcome suggests that implementing trade liberalization policies by deepening the integration of the Sierra Leone economy to the global economy would support the price stability objective of the Bank of Sierra Leone.