Dynamics of Core Inflation, Energy Inflation, Food Inflation and Manufacturing Sector Output Growth in Kenya: Econometric Analysis of Causality and Effects

Abstract

World over, the manufacturing sector plays an important role in spurring economic development by boosting employment opportunities for semi-skilled labour and building a nation’s competitiveness through exports. Globally, only a few nations have managed to realize their development status without manufacturing sector playing a leading role. Kenya has not managed to develop a robust manufacturing sector and its growth has been majorly ascribed to the agricultural and service sectors. It has therefore, experienced de industrialization as evidenced by the decline in GDP contribution by the manufacturing sector from a paltry 10% in 2018 to 9.7% in 2019. The de industrialization has been characterized by fluctuating inflation rates, a scenario that has elicited debate as to whether there exists any nexus between manufacturing sector output growth and inflation rate. A few empirical studies have been conducted on the same, however, the exact relationship is not well defined. Furthermore, inflation has been largely treated as an aggregate, a scenario that hampers policy formulation. A disaggregated approach to the analysis thus motivated this study. Time series data from the world bank was used and VECM estimated to assess long run dynamics after stationarity test by ADF and Cointegration test by Johannes’s approach. Short run causalities were assessed via Wald test. The study revealed long run relationship between manufacturing output growth and the variables (core inflation, energy inflation and food inflation). Short run causality running from each of the inflation types to manufacturing output growth also exists.  Food inflation negatively and significantly influences manufacturing output growth while core inflation has significant positive effect on the same. To enhance manufacturing output growth in Kenya, food inflation should be reduced and stabilized. In the same vain, low and stable level of core inflation should be ensured over time.

Keywords: Inflation, Manufacturing Sector, Dynamics, Econometrics, Causality, Kenya

DOI: 10.7176/JESD/12-2-05

Publication date: January 31^st 2021