Working Paper 151 - The Dynamics of Inflation in Ethiopia and Kenya

This study provides an assessment of the main drivers of inflation in Ethiopia and Kenya by developing single-equation error correction models for the Consumer Price Index in each country. This approach takes into account a number of potential sources of the recent surge in inflation, including excess money supply, exchange rates, food and non-food world prices, world energy prices and domestic agricultural supply shocks. We find that the inflation rates in both Ethiopia and Kenya are driven by similar factors; world food prices and exchange rates have a long run impact, while money growth and agricultural supply shocks have short-to-medium run effects. There is also evidence of substantial inflation inertia in both countries. The key conclusion is that there is no nominal anchor for inflation in either country in the form of a clear and well-functioning monetary or exchange rate policy.