The Relationship between Inflation and Economic Growth in East African Community Countries

Abstract

The relationship between inflation and economic growth has been of great concern to most countries and regions across the world. Several studies have attempted to explain the linear association, long run and causal relationship between inflation and economic growth however their findings have been somewhat inconsistent. For East African Community (EAC) countries, studies on the linear association, long run and causal relationship between inflation and economic growth have also been done although mainly dwelling on time series analysis. Coincidentally, their results have also shown inconsistent findings. The community being a trading block and in pursuit of regional integration, available studies have failed to explain the exact relationship that exist between inflation and economic growth in the region. In this regard, the study sought to establish the exact relationship that exists between inflation and economic growth in the community for the period (1990-2014) using panel time series approach. The study objectives were to determine the linear association between inflation and economic growth, establish the long run relationship between inflation and economic growth and determine the causal relationship between inflation and economic growth in EAC countries. The study presented panel data for 5 countries in the community and applied Robust Least Square estimation technique with fixed effects. The study was anchored on Solow growth model and employed correlation research design. Structural breaks at entry point to the community were accounted for by introducing a dummy variable in the model. Stationarity test was carried out on variables and found that GDP and inflation were stationary at level. Estimation results showed that inflation had a negative (- 0.1341) and significant effect on economic growth at 5% significance level and the effect remained negative (- 0.1129) but statistically insignificant after introducing a dummy variable to the model. Considering the objectives of the study, Correlation analysis showed that there exist a weak negative (-0.0067) linear association between inflation and economic growth in EAC countries. Co-integration results revealed that there exist a long run relationship between inflation and economic growth in EAC countries while result for causality analysis showed that there exists a uni-directional causal relationship from economic growth to inflation at 5% level of significance although the effect would be effective after 2 years. In conclusion, inflation negatively and significantly affect economic growth however, considering the structural breaks in EAC, the negative effect inflation reduces and becomes statistically insignificant to economic growth. That is, the time of entry to EAC has positive effect and thus reduce the negative effect inflation has on economic growth. In this regard, policies need to be put in place to keep inflation rate moderate and stable to ensure that the negative effect inflation has on economic growth is minimized in these countries