Threshold Effects in the Relationship between Inflation and Economic Growth in Kenya: 1970-2014
Loading...
Date
2017-07
Authors
Mugi, Njenga Kelvin
Journal Title
Journal ISSN
Volume Title
Publisher
Kenyatta University
Abstract
It is widely agreed among economists, policy makers and central bankers that all macroeconomic
policies seek to attain high levels of economic growth coupled with very low rates of inflation.
High inflation rates have resulted to a number of adverse effects on the economic growth of
many countries over time. But how low should the inflation rate be so as not to affect economic
growth negatively? Economic policymakers in Kenya have been working towards the attainment
of a 5 percent rate of inflation as the most ideal rate for economic policy purposes. Is this rate of
inflation the most appropriate for economic growth? Recent studies have demonstrated that,
inflation only causes detrimental effects in an economy in the event it rises beyond a specific
threshold depending on the level of economic development of an economy and the existing
economic structure. If the level of inflation is below the identified threshold, then the effect of
inflation on economic growth is insignificant or even positive. In an attempt to determine
whether or not there existed threshold effects between these two variables of interest in Kenya,
this study assumed that economic growth and inflation had a non-linear relationship and used
quarterly data spanning the sample period 1970-2014. This study sought;to determine if a first
threshold inflation level exists in the relationship between inflation and economic growth in
Kenya; to determine if a second threshold inflation level exists in the relationship between
economic growth and inflation rate in Kenya; to establish the effect of inflation on the level of
economic growth at the estimated lower and upper threshold levels of inflation in Kenya; and to
analyze the impact of a structural break on the threshold regression model for the Kenyan
economy. A suitable regression model for the threshold was used in this study. The results
revealed the existence of two significant threshold levels at 6.1318% and 9.6274%. Inflation
causedpositive and significant effects on economic growth at inflation rates below the first
threshold level. The effect of inflation on economic growth was also positive and significant at
all inflation rates between the two threshold levels. However, at inflation rates above the second
threshold level, inflation had a negative effect on the level of economic growth. This study also
showed that failure to account for structural breaks in the relationship between economic growth
and inflation largely influenced the estimated effects of inflation on growth at the identified
threshold levels. The findings of this study provide an important basis for the formulation of
monetary policy in Kenya given that they act as a guide in the setting of inflation targets. The
findings further provide economic policymakers in Kenya with consistent guidance on matters of
inflation in the actualization of long-term economic growth targets.
Description
A Research Project Submitted to the Department of Econometrics and Statistics, in Partial Fulfilment of the
Requirement for the Award of a Degree in Masters of Economics (Econometrics) of Kenyatta University.
July, 2017
Keywords
Inflation, Economic Growth, Kenya, 1970-2014