The relationship between inflation and economic growth in Kenya, 1963-2003
Low economic growth and fluctuating inflation rates have been experienced over the years in Kenya. The relationship between inflation and economic growth has brought a lot of controversy both in theory and empirical literature. This study sought to establish if there is significant causality between inflation and economic growth, the specific nature of this relationship and to determine whether there is a short run or long run relationship between these two variables. The study examined the relationship between these two variables using annual data covering the period 1963 to 2003. The Phillips curve approach was used in this study. To undertake this study, published data was used. The data were tested for the presence of unit roots, which revealed that inflation was an 1 (1) and real GDP growth rate was an 1 (0). Granger causality tests revealed that there was no causality between inflation and economic growth rate. Estimations were done using OLS estimation technique. Various diagnostic tests were also carried out to confirm the statistical soundness of the models. The study found that there was a negative short run relationship between inflation and economic growth. Further, this relationship was positive in the long run. These results showed that inflation was affected by its own first and second lags, economic growth, climatic shocks (for example drought), monetary policy interventions and external shocks like the oil price. On the other hand, economic growth was affected by its first and second lags only. In this case, the Phillips curve approach was not applicable since it presents a short run positive relationship between inflation and economic growth while the results presented an inverse short run relationship and a direct long run relationship between inflation and economic growth in Kenya.