Inflation and Economic Growth in Kenya: An Empirical Examination

Authors

  • TALKNICE SAUNGWEME UNIVERSITY OF SOUTH AFRICA Corresponding Author
  • Nicholas M Odhiambo Author

DOI:

https://doi.org/10.47654/v25y2021i3p1-25

Keywords:

inflation, economic growth, ARDL, Granger-causality, Kenya

Abstract

Purpose

This paper examines the relationship between inflation and economic growth in Kenya from an analytical and empirical standpoint.

Design/methodology/approach

The paper applies the autoregressive distributed lag (ARDL) bounds testing approach and the multivariate Granger-causality test using time series data covering 1970-2019. Structural breaks in the time series were also conducted using the Perron (1997) (PPURoot) and Zivot-Andrews (1992) (ZAU Root) techniques. Incorporating structural breaks into time series increases statistical inference's overall validity.

Findings

Inflation and economic growth in Kenya were found to have structural breaks in 1995 and 1991. These years are marked by Kenya's economic, financial, public sector and institutional reforms. The other findings of the study revealed that inflation has a statistically significant negative influence on long-term economic growth. The multivariate Granger-causality results showed a distinct short-run unidirectional causality from economic growth to inflation in Kenya.

Practical implications

In order to mitigate the negative consequences of inflation and the coronavirus on the economy and welfare, the study recommends that Kenya's government should pursue prudent monetary, financial, and fiscal policies.

References

Andrés, J. & Hernando, I. (1997). Does inflation harm economic growth? Evidence for the OECD. NBER Working paper no. 6062. Retrieved April 29.2021 from https://www.nber.org/papers/w6062

Andrés, J., Hernando, I. & Lopez-Salido, J.D. (2004). The role of the financial system in the growth-inflation link: the OECD experience. European Journal of Political Economy, 20(4), 941-961.

Arawatari, R., Hori, T. & Mino, K. (2018). On the nonlinear relationship between inflation and growth: a theoretical exposition. Journal of Monetary Economics, 94(C), 79-93. https://doi.org/10.1016/j.jmoneco.2017.12.001

Aye, G.C. & Odhiambo, N.M. (2021). Threshold effect of inflation on agricultural growth: evidence from developing countries. Advances in Decision Sciences (ADS), 25(2), 1-22. https://doi.org/10.47654/v25y2021i2p28-50

Benhabib, J. & Spiegel, M.M. (2009). Moderate inflation and the deflation: depression link. Journal of Money, Credit and Banking, 41(4), 787-798. https://doi.org/10.1111/j.1538-4616.2009.00232.x

Bevan, D., Collier, P. & Gunning, J.W. (1999). Anatomy of a temporary trade shock: the Kenyan coffee boom of 1976-79, In, Trade shocks in developing countries, Collier, P. & Gunning, J.W, (eds). Oxford: Oxford University Press.

Bigsten, A. (2002). History and policy of manufacturing in Kenya, In: Structure and performance of manufacturing in Kenya, Bigsten, A. & Kimuyu, P, (eds). New York: Palgrave.

Bigsten A., Kimuyu, P. & Söderbom M. (2010). The manufacturing sector, In Adams, C., Collier, P., Ndungu, N, (eds), Kenya: Policies for Prosperity. Oxford: Oxford University Press.

Blanchard, O.J. & Kiyotaki, N. (1987). Monopolistic competition and the effects of aggregated demand. American Economic Review, 77(4), 746-766.

Boianovsky, M. (1968). Furtado and the structuralist-monetarist debate on economic stabilisation in Latin America. Retrieved May 01.2021 from https://core.ac.uk/download/pdf/6228544.pdf

Butkiewicz, J.L. & Yanikkaya, H. (2011). Institutions and the impact of government spending on growth. Journal of Applied Economics, 14(2), 319-341.

Cameron, N., Hum, D. & Simpson, W. (1996). Stylized facts and stylized illusions: inflation and productivity revisited. Canadian Journal of Economics, 29(1), 152-162.

Chu, A.C., Cozzi, G., Furukawa, Y. & Chih-Hsing, L. (2017). Inflation and economic growth in a Schumpeterian model with endogenous entry of heterogeneous firms. European Economic Review, 98(2017), 392-409. https://doi.org/10.1016/j.euroecorev.2017.07.006

Cooley, T.F. & Hansen, G.D. (1989). The inflation tax in a real business cycle model. American Economic Review, 79(4), 733-748. Retrieved April 26.2021 from http://people.stern.nyu.edu/tcooley/papers/the_inf_tax_in_a_rea_bus_cyc_mod.pdf

De Gregorio, J. (1996). Borrowing constraints, human capital accumulation, and growth. Journal of Monetary Economics, 37(1), 49-71. https://doi.org/10.1016/0304-3932(95)01234-6

Dornbusch, R., Fischer, S. & Kearney, C. (1996). Macroeconomics. Sydney: The Mcgraw-Hill Companies.

Dudzevičiūtė, G., Šimelytė, A. & Liučvaitienė, A. (2016), Government expenditure and economic growth in the European Union countries. International Journal of Social Economics, 45(2), 372-386.

Durevall, D. & Ndung'u, N.S. (1999). A dynamic model of inflation for Kenya, 1974-1996. IMF papers, 1999(97), 4-29. https://doi.org/10.5089/9781451852004.001

Eggoh, J.C. & Muhammad, K. (2014). On the nonlinear relationship between inflation and economic growth. Research in Economics, 68(2014), 133-143. https://doi.org/10.1016/j.rie.2014.01.001

Fama, E.F. (1982). Inflation, output, and money. The Journal of Business, 55(2), 201-231. https://doi.org/10.1086/296161

Fama, E.F. & Schwert, G. (1977). Asset returns and inflation. Journal of Financial Economics, 5(2), 115-146. https://doi.org/10.1016/0304-405X(77)90014-9

Faria, J.R. & Carneiro, F.G. (2001). Does high inflation affect growth in the long and short run? Journal of Applied Economics, 4(1), 89-105. https://doi.org/10.1080/15140326.2001.12040559

Fischer, I. (1911). The purchasing power of money. New York: Macmillan.

Fischer, S. (1993). The role of macroeconomic factors in growth. Journal of Monetary Economics, 32(3), 485-511. https://doi.org/10.1016/0304-3932(93)90027-D

Foroutan, F. (1993). Trade reform in ten sub-Saharan African countries: achievements and failures. World Bank policy research paper no. 1222.

Fountas, S., Karanasos, M. & Kim, J. (2006). Inflation uncertainty, output growth uncertainty and macroeconomic performance. Oxford Bulletin of Economics & Statistics, 68(3), 319-343. https://doi.org/10.1111/j.1468-0084.2006.00164.x

Friedman, M. (1968). The role of monetary policy. The American Economic Review, 58(1), 1-17. Retrieved April 14.2021 from https://www.fep.up.pt/docentes/pcosme/CIF_1Ec101_2014/Freedman1968.pdf

Gertz, G. (2009). Kenya's trade liberalisation of the 1980s and 1990s: policies, impacts, and implications. Retrieved April 22.2021 from https://carnegieendowment.org/files/kenya_background.pdf

Ghosh, A. & Phillips, S. (1998). Warning: inflation may be harmful to your growth, IMF Staff Papers, 45(4), 672-710. Retrieved 21 April 2021 from https://www.imf.org/external/pubs/ft/staffp/1998/12-98/pdf/ghosh.pdf

Gillman, M. & Harris, M.N. (2010). The effect of inflation on growth: evidence from a panel of transition countries. Economics of Transition and Institutional Change, 18(4), 697-714. https://doi.org/10.1111/j.1468-0351.2009.00389.x

Gillman, M. & Kejak, M. (2011). Inflation, investment and growth: a money and banking approach. Economica, 78(310), 260-282. https://doi.org/10.1111/j.1468-0335.2009.00814.x

Gillman, M., Haris, N.M. & Matyas, L. (2004). Inflation and growth: explaining a negative effect, Empirical Economics, 29(1), 149-167. https://doi.org/10.1007/s00181-003-0186-0

International Monetary Fund (IMF) (2010). Kenya: staff report for the 2009 Article IV consultation. IMF Country Report No. 10/26. Washington, DC.

International Monetary Fund (IMF) (2014). 2014 Article IV consultation – staff report; press release; and statement by the executive director for Kenya. IMF Country Report No. 14/302. Washington, DC.

International Monetary Fund (IMF). (2020). Republic of Kenya request for disbursement under the rapid credit facility – Press release; staff report; and statement by the executive director for the Republic of Kenya. IMF Country Report No. 20/156.

International Monetary Fund (IMF) (2021). Requests for an extended arrangement under the extended fund facility and an arrangement under the extended credit facility – Press release; staff report; and statement by the executive director for Kenya. IMF Country Report No. 21/72. Washington, DC.

Iqbal, N. & Nawaz, S. (2009). Investment, inflation and economic growth nexus. The Pakistan Development Review, 48(4), 863-874. Retrieved April 20.2021 from http://www.pide.org.pk/pdf/PDR/2009/Volume4/863-874.pdf

Keynes, J.M. (1964). The general theory of employment, interest, and money. Retrieved April 21.2021 from https://www.files.ethz.ch/isn/125515/1366_KeynesTheoryofEmployment.pdf

Kimenyi, M.S., Mwega, F.M. & Ndung’u, N.S. (2016). Understanding the African lions: growth traps and opportunities in six dominant African countries: the African Lions: Kenya country case study. Retrieved April 28.2021 from https://www.wider.unu.edu/sites/default/files/wp2015-134.pdf

Kremer S., Bick A. & Nautz D. (2013). Inflation and growth: new evidence from a dynamic panel threshold analysis. Empirical Economics, 44(2), 861-878. https://link.springer.com/article/10.1007/s00181-012-0553-9

Lin, J.L. (2008). Notes on testing causality. Retrieved June 19.2021 from http://faculty.ndhu.edu.tw/~jlin/files/causality.pdf

López-Villavicencio, A. & Mignon,V. (2011). On the impact of inflation on output growth: does the level of inflation matter? Journal of Macroeconomics, 33(3), 455-464. https://doi.org/10.1016/j.jmacro.2011.02.003

Lucas, R. (1973). Some international evidence on output-inflation trade-offs. American Economic Review, 63(3), 326-334.

Lütkepohl, H. (1982). Non-causality due to omitted variables. Journal of Econometrics, 19(2-3), 367-378. https://doi.org/10.1016/0304-4076(82)90011-2

Mallik, G. & Chowdhury, A. (2001). Inflation and economic growth: evidence from South Asian countries. Asian Pacific Development Journal, 8(1), 123-135.

Manamba, E. (2016). Nonlinearities in inflation and growth nexus: the case of Tanzania. Journal of Economics and Political Economy, 3(3), 471-512. Retrieved April 30.2021 from https://ideas.repec.org/a/ksp/journ1/v3y2016i3p471-512.html

Marcuzzo, M.C. & Rosselli, A. (1994). Ricardo's theory of money matters. Revue économique Année, 45(5), 1251-1268.

Mayes, D.G. & Virén, M. (2004). Asymmetries in the Euro area economy. Bank of Finland Discussion Papers 9/2004.

Ming-Tang, L. (1967). Keynes's theory and inflation. A Master's Report. Kansas State University.

Mishkin, F.S. (2000). From monetary targeting to inflation targeting: lessons from the industrialised countries. Retrieved May 01.2021 from https://www0.gsb.columbia.edu/faculty/fmishkin/PDFpapers/00BOMEX.pdf

Mundell, R.A. (1963). Inflation and real interest. Journal of Political Economy, 71(1963), 280-283. https://doi.org/10.1086/258771

Narayan, P.K. & Smyth, R. (2008). Energy consumption and real GDP in G7 Countries: new evidence from panel cointegration with structural breaks. Energy Economics, 30, 2331-2341. https://doi.org/10.1016/j.eneco.2007.10.006

Ndoricimpa, A. (2017). Threshold effects of debt on economic growth in Africa. African Development Review, 29(3), 471-484. https://doi.org/10.1111/1467-8268.12282

Ndung'u, N. (2010). Njuguna Ndung'u: talking notes on the state of Kenya's economy. Presentation made at the American Chamber of Commerce of Kenya monthly luncheon, Nairobi, 20 July 2010. Retrieved April 30.2021 from https://www.bis.org/review/r100729c.pdf

Ngui, D., Chege, J. & Kimuya, P. (2016). Manufacturing transformation: comparative studies of industrial development in Africa and emerging Asia: Kenya's industrial development. Oxford Scholarship. Retrieved April 27.2021 from https://oxford.universitypressscholarship.com/view/10.1093/acprof:oso/9780198776987.001.0001/acprof-9780198776987-chapter-4?print=pdf

Odhiambo, N.M. (2008). Financial depth, savings and economic growth in Kenya: a dynamic causal linkage. Economic Modelling, 25(4), 704-713. https://doi.org/10.1016/j.econmod.2007.10.009

Odhiambo, N.M. (2021). Foreign direct investment and economic growth in Kenya: an empirical investigation. International Journal of Public Administration, 1-12. https://doi.org/10.1080/01900692.2021.1872622.

Ozdemir, Z.A. (2010). Dynamics of inflation, output growth and their uncertainty in the UK: an empirical analysis. The Manchester School, 78(6), 511-537. https://doi.org/10.1111/j.1467-9957.2009.02153.x

Perron, P. (1989). The great crash, the oil price shock, and the unit root hypothesis. Econometrica, 57(6), 1361-1401.

Perron, P. (1997). Further evidence on breaking trend functions in macroeconomic variables. Journal of Econometrics, 80(2), 355-385. https://doi.org/10.1016/S0304-4076(97)00049-3

Perroux, F. & Lisle, E.A. (1957). Structural inflation and the economic function of wages: the French example 1. Retrieved April 30.2021 from https://link.springer.com/chapter/10.1007%2F978-1-349-15205-6_16

Perry, G.L. (1978). Slowing the wage-price spiral: the macroeconomic view. Retrieved April 30.2021 from https://www.brookings.edu/wp-content/uploads/1978/06/1978b_bpea_perry_baily_poole.pdf

Perry, G.L. (1980). Inflation in theory and practice. Retrieved April 29 from https://www.brookings.edu/wp-content/uploads/1980/01/1980a_bpea_perry_fellner_ gordon_duesenberry_hall_sims_nordhaus_marris_juster_shoven_friedman_tobin.pdf

Pesaran, M.H. & Shin, Y. (1999). An autoregressive distributed lag modelling approach to cointegration analysis. In, S. Storm, (Ed.), Econometrics and Economic Theory in the 20th Century: the Ragnar Frisch Centennial Symposium (Chapter 11, pp. 1–31). Cambridge University Press.

Pesaran, M., Shin, Y. & Smith, R. (2001). Bounds testing approaches to the analysis of level relationships. Journal of Applied Econometrics, 16(3), 289-326. https://doi.org/10.1002/jae.616

Phiri, A. (2018). Nonlinear impact of inflation on economic growth in South Africa: a smooth transition regression analysis. International Journal of Sustainable Economy, 10(1), 1- 17. https://doi.org/10.1504/IJSE.2018.088624

Pigou, A.C. (1936). Mr. J. M. Keynes's general theory of employment, interest, and money. Economica, III (May), 115-32.

Ramzi, T. & Wiem, J. (2019). Causality nexus between economic growth, inflation and innovation. Journal of the Knowledge Economy, 10(1), 35-58. DOI: https://doi.org/10.1007/s13132-016-0432-2

Rapach, D. (2003). International evidence on the long-run impact of inflation. Journal of Money, Credit Bank, 35(1), 23-48.

Rewilak, J. (2017). The role of financial development in poverty reduction. Review of Development Finance, 7(2), 169-176. https://doi.org/10.1016/j.rdf.2017.10.001

Rutayisire, M. (2013). Threshold effects in the relationship between inflation and economic growth: evidence from Rwanda. AERC Research Paper 293. Retrieved May 01.2021 from https://media.africaportal.org/documents/RP293.pdf

Sarel, M. (1996). Nonlinear effects of inflation on economic growth. IMF Staff Papers, 43(1), 199-215.

Saungweme, T. & Odhiambo, N.M. (2021). Relative impact of domestic and foreign public debt on economic growth in South Africa. Journal of Applied Social Science, 15(1), 132-150. https://doi.org/10.1177/1936724420980414

Sidrauski, M. (1967). Rational choice and patterns of growth in a monetary economy. American Economic Review, 57(2), 534-544.

Solow, R.M. (1956). A contribution to the theory of economic growth. Quarterly Journal of Economics, 70(1), 65-94.

Stockman, A.C. (1981). Anticipated inflation and the capital stock in a cash-in-advance economy. Journal of Monetary Economics, 8(3), 387-393.

Swamy, G. (1994). Kenya: structural adjustment in the 1980s. World Bank, policy research working paper no. 1238.

Taylor, L. (1983). Structuralist macroeconomics: applicable models for the third world. Basic: New York.

Tobin, J. (1965). Money and economic growth. Econometrica, 33(4), 671-684.

Tobin, J. (1972). Inflation and unemployment. American Economic Review, 62(1/2), 1-18.

World Bank (1989). The consistency of government deficits with macroeconomic adjustment: an application to Kenya and Ghana. Working paper series no. 287.

World Bank (2020). World development indicators. Online database.

Zeleza, T. (1991). Economic policy and performance in Kenya since independence. Transafrican Journal of History, 20(1991), 35-76.

Zivot, E. & Andrews, D.W.K. (1992). Further evidence on the great crash, the oil price shock and the unit root hypothesis. Journal of Business and Economic Statistics, 10(3), 251-270.

Published

2021-10-22

How to Cite

SAUNGWEME, T., & Odhiambo, N. M. (2021). Inflation and Economic Growth in Kenya: An Empirical Examination. Advances in Decision Sciences, 25(3), 1-25. https://doi.org/10.47654/v25y2021i3p1-25